Prospect theory builds on behavioural research in modern psychology
which demonstrates that people are more loss averse than gain seekers
(utility maximizers).
Other economists have succeeded to demonstrate irrational behaviours of
economic actors (heuristics, dissonances, biases, magical thinking and
so on).
The apparent chasm between the rational theories (efficient markets,
hidden hands and so on) and behavioural economics is the result of two
philosophical fallacies which, in turn, are based on the misapplication
and misinterpretation of philosophical terms.
The first fallacy is to assume that all forms of utility are reducible
to one another or to money terms. Thus, the values attached to all
utilities are expressed in monetary terms. This is wrong. Some people
prefer leisure, or freedom, or predictability to expected money. This
is the very essence of risk aversion: a trade off between the utility
of predictability (absence or minimization of risk) and the expected
utility of money. In other words, people have many utility functions
running simultaneously - or, at best, one utility function with many
variables and coefficients. This is why taxi drivers in New York cease
working in a busy day, having reached a pre-determined income target:
the utility function of their money equals the utility function of
their leisure.
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