Source: Laboratory of Jonathan Flombaum—Johns Hopkins University
What’s the value of a dollar? Currencies store value to facilitate trade. Implied in any economic transaction is the value of a unit of currency. But what is the subjective value of a dollar? For a long time, economists assumed the answer to this question to be, specifically, that a dollar has a value determined by the market and that the subjective value of a dollar is always that, more or less.
Beginning in the early 1970s, experimental psychologists Daniel Kahneman and Amos Tversky upended this assumption, showing that the subjective value of currency depends on a number of factors, most notably, whether losses or gains are being discussed, and the overall size of a transaction. To pump intuition, consider the fact that, to most people, it would seem reasonable to drive an extra half-mile in order to save $2 on a gallon of gas. But very few people would do the same to save $2 on the cost of a new car. So $2 is sometimes, but not always worth an extra half-mile drive. Value is context-dependent.
The theory devised by Kahneman and Tversky to describe how people psychologically value currency (and goods and services, generally) is called Prospect Theory. In 2002, Kahneman was awarded the Nobel Prize in Economics for Prospect Theory, along with related research using the methods and theories of experimental psychology to understand economic decision-making (Tversky passed away in 1996.).
Many of the primary implications of Prospect Theory were obtained through survey experiments. The surveys consisted of choices between gambles; for example, subjects might be asked whether they would prefer to receive $5 or risk receiving nothing with a 50% chance of winning $10.
This video will demonstrate procedures for designing the type of survey questions used in research on Prospect Theory.
1. Stimulus design
| A | B |
| [4000,1] | [5000, .9] |
| [-4000,1] | [-5000, .9] |
| [5,1] | [10, .9] |
| [-5,1] | [-10, .9] |
| [5000, .9] | [10,000, .45] |
| [5000, .04] | [10,000, .02] |
Table 1. The first number in each bracket denotes a currency value, and the second denotes the probability associated with that outcome.
2. Procedure
"Prospect Theory" was devised by Daniel Kahneman and Amos Tversky, beginning in the 1970s, as a way to describe how people psychologically value currency.
On one hand, any unit of currency-like the US dollar-has an objective value, determined by the market. If a person is preparing to travel abroad and exchanging currency, it is this objective value that will dictate how many euros they can expect to receive for fifty dollars.
However, currency can also have a subjective, psychological value, which a person "assigns" to it based on many different factors, including the size of the purchase they are considering and potential relative savings.
To elaborate, a person may be willing to drive an extra mile to save two dollars on every gallon of gas, but not to save the same amount on a new, $20,000 car. Thus, two dollars is sometimes-but not always-worth an extra mile trip.
Originally formulated using survey data, Prospect Theory provides researchers with a model to predict an individual's subjective perceptions of objective monetary gains or losses.
In this video, you will learn how to create survey questions to study Prospect Theory, collect and analyze participant data in the form of survey responses, and learn how these can provide insight into the psychological value people place on currency.
In this experiment, participants complete a survey with questions pertaining to gambles-theoretical events in which they could potentially lose or gain a sum of money.
In questions dealing with gains, a scenario is presented where the participant has already received money-like winning five dollars in a raffle.
The participant must then choose between two options as to what to do with the sum: either keep all of it, or risk it for a chance to win a higher amount.
Similarly, when a participant encounters a loss question, they must pick between options of paying a debt, or risking a greater loss for a chance to have the debt erased.
The trick here is that both options to a question have the same expected value-the average amount of money gained or lost over several trials-which takes into account the probability of a win or loss.
It's the manner in which these values are presented-either as "sure things" or "risks" with a lower probability of success-which allows for an assessment of the subjective, psychological value of currency.
Participants are presented with a variety of such questions in a survey, where the probabilities of gains or loses-as well as the actual monetary amounts at stake-vary.
Here, the dependent variable is the subjective value of currency, which is determined by calculating the percentage of participants that chose a particular option to a question.
Based on the previous work of Kahneman and Tversky, it is expected that participants will overestimate the subjective value of monetary losses, especially small ones, viewing them as worth more than their actual, objective values.
To begin, create a survey with roughly 20 questions, and include questions dealing with diverse loss and gain scenarios.
Verify that both options associated with each question demonstrate the same expected value, as well as a range of monetary values with risks associated with different probabilities.
Before distributing the survey to participants, generate a cover page to include with informed consent, which explains to participants that they do not have to complete the questions, and that their responses are anonymous. Make sure to include a signature line for participants to indicate their consent.
Once the survey is finalized, distribute it to between 50 and 100 randomly selected participants. Note that individuals can be tested in groups. Allow them 15 min to complete the 20 questions.
When the participants are done, collect the surveys.
To analyze the data, for every question calculate the percentage of participants that chose each option-either A or B.
Compare participant preferences in similar questions, such as those dealing with small sums of money either lost or won.
Notice that more participants will tend to take a risk to avoid a financial loss compared to an equivalent gain, meaning that a greater subjective value is placed on monetary losses.
Also notice that participants will be less likely to risk large sums in gain scenarios, indicating that their subjective value of monetary gains can decrease depending on the context.
Now that you've learned how to create surveys to study Prospect Theory, let's take a look at how experimental psychologists are using this theory to investigate aspects of decision-making behavior.
As surveys that assess Prospect Theory deal with monetary losses and gains, these studies can aid our understanding of the psychological underpinnings of gambling and gambling addiction.
Importantly, such work has allowed researchers to connect the high subjective value of monetary losses to the tendency to keep gambling even as debts mount.
Researchers can also pair automated variations of Prospect Theory surveys with technologies like functional MRI, which can identify "activated" brain regions. This helps scientists determine the neuroanatomical basis for how participants assign subjective values to monetary sums under different situations.
Finally, Prospect Theory can also be used to develop new marketing strategies, such as stores offering perceived discounts on lower-priced items, to which consumers would assign high subjective values.
You've just watched JoVE's video on Prospect Theory. By now, you should have an idea of how to design survey questions to investigate this phenomenon, collect and analyze participants' responses, and relate the Prospect Theory to human behaviors like gambling.
In addition, you should have a grasp of how the Prospect Theory relates to the subjective and objective values of currency, which are not always the same.
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