Reasoning Critical Thinking Final Exam Review Define what an argument is o A connected series of events statements premises that are intended to give reasons to believe some further statement conclusion is true Explain what it is for an argument to be valid and what it is for an argument to be sound o Valid Argument If premises are true then it is impossible for the conclusion to be false o Sound Argument All of the premises are true and it is valid Explain the difference between deductive and inductive arguments o Deductive Arguments attempts to be valid and contains facts not opinions o Inductive Arguments Designed to be strong and show that the conclusion is probable given the truth of the premises Explain the differences between a descriptive theory and a prescriptive theory o Descriptive Theory what you in fact should do in situations o Prescriptive Theory what you ideally should do in situations but Explain the differences between expected utility theory and prospect theory usually do not o Prospect theory focuses on 1 Gains and loses 2 Requires an evaluation relative to a reference point 3 Holds that people are loss averse Be able to identify prospect theory s graph and explain how it displays the main features of prospect theory o You place more value in a loss than you do in the same gain because we are much more sensitive to losses Be able to identify and explain the fourfold pattern table High Probability Certainty Effect Low Probability Possibility Effect Gains 95 chance to win 10 000 Fear of disappointment RISK AVERSE 5 chance to win 10 000 Hope of large gain RISK SEEKING Losses 95 chance to lose 10 000 Hope to avoid loss RISK SEEKING 5 chance to lose 10 000 Fear of large loss RISK AVERSE o The decisions we are inclines to make in the fourfold pattern are irrational but they are enticing because we have a narrow view of decisions Explain what loss aversion is and identify it at work in explaining why we make decisions o People s tendency to strongly prefer avoiding losses to acquiring gains Losses are about 1 5x more powerful mentally than gains o Loss aversion also explains Why we tend to maintain the status quo Why bargaining and negotiations are difficult Define and explain the endowment effect o Endowment Effect people tend to place more value on what they own The willingness to buy or sell x depends on the reference point Does NOT apply to things held for exchange o To combat think like a trader Ask yourself How much do I want to have X compared with other things I could have instead The difference between the pleasure of getting and the Define and explain the possibility effect pain of giving up is irrelevant o Possibility Effect The tendency to overweight the likelihood of improvable events Highly unlikely outcomes are overweighted Define the certainty effect probable events o Certainty Effect the tendency to underweight the likelihood of Highly likely outcomes are underwehigted Much of this overweighting and underweighting is explained by our aversion to loss Explain why and how we are influenced by the possibility effect and certainty effect o Focused Attention If a statement is most likely to be false we focus on how to make it true Also works if a statement is most likely to be true we focus on how to make it false o Confirmation Bias only recalling the times that our predictions were correct and forgetting the times we are wrong o Cognitive Ease in focusing this attention we imagine all the sorts of vivid scenarios that make it true which gives us a high sense of fluency or to be able to easily understand Explain denominator neglect and identify when it takes place o Denominator Neglect We ignore the denominator in probability and focus instead on the numerator Example A 1 10 chance to win 100 or a 8 100 chance to win 100 Untrained people will see the 8 as larger than 1 and automatically chose the 8 100 chance even though it is a lower chance because of the largeness of the denominator Explain the impact of presenting information as frequency or abstract probability on denominator effect o Frequency shows the exact unit of the probability Example Lung Cancer kills 3 452 people per 10 000 o Abstract hides the exact numbers and is easier to over look Example Heart Disease kills 32 5 of the population We are much more reactive to frequency rates Explain what mental accounting is and give some examples of mental accounts o Mental Accounting We tend to value some dollars more than other dollars depending on the source of those dollars We undervalue dollars when they aren t as vivid to us and involve no visceral loss Example Credit cards vs cash Money given to us by our parents v Money we have worked for We undervalue found money Gambling Tax refunds Bonuses Explain how to avoid mental accounting o To avoid mental accounting Imagine you always pay in cash Consider big purchases in terms of their components and assess each component Wait before spending found money Imagine all your money is hard earned money Define sunk costs and explain the sunk cost fallacy o Sunk Costs costs that are already paid o Sunk costs are gone and cannot be regained no matter what decision you make so it is not rational to honor sunk costs when making a decision o Sunk Cost Fallacy Honoring sunk costs when those sunk costs should not be honored Example We have spent so much tax payer money on this road we cannot just abandon it for a better opportunity The sunk cost principle says that decisions should only be Be able to identify instances of sunk cost reasoning based on future costs and benefits o Why do people honor sunk costs They don t want to be wasteful They don t want to admit an error o Continuing on with something even though it is no longer beneficial because so much effort or cost has already been sunk into it Explain reputation costs and how they are relevant to sunk cost reasoning o Reputation Costs When you chose to change your position mind or actions you may lose your good reputation and be questioned by others o Ignoring sunk costs is linked to reputation costs because it can cause others to pass negative judgments about you that may be future reputation costs Define and explain the framing effect including the effects some presentation has on how we tend to make decisions o The Framing Effect Because we are loss averse the way in which an issue is framed or described can influence our decision response People seek risk when the problem is framed negatively in