Kahneman and Tversky's Prospect Theory

Prospect Theory, developed by Daniel Kahneman and Amos Tversky, explains how people make decisions involving risk and uncertainty. It shows that individuals don't always act rationally; they tend to value potential losses more heavily than equivalent gains, leading to loss aversion. People also assess probabilities unevenly, overweighing small chances and underweighing large ones. Instead of always optimizing for maximum expected value, they make choices based on subjective evaluations of gains and losses relative to a reference point, often resulting in choices that deviate from traditional economic rationality.