# Kahneman and Tversky Decision experiments contradict Neumann-Morgensterns utility theory [duplicate]

I want to know the reason why Kahneman and Tversky Decision experiments contradict Neumann-Morgensterns utility theory.

Could anyone please ellaborate this to me? Thanks.

• You need to show some effort, we are not a homework-doing machine. Which experiments are you referring to? Have you at least read some Wikipedia articles on the topic before asking the question? – Oliv Mar 30 '17 at 10:41
• @Oliv Thanks. I agree with you. I appreciate your involvement in this conference. Actually I got the solution for this problem here "economics.stackexchange.com/questions/95/…" – UserAb Mar 30 '17 at 10:55

I will write out some generalized comments here because I am incredibly interested in the contributions of experimental economics to our understanding of economic man. Further, I am not convinced entirely that this is a homework question. The real thing here is that I think many other people - especially undergrads possibly interested in pursuing graduate school - might find the answer both interesting and compelling.

So, here is a brief outline of what could be a more complete answer:

Foremost, I recommend you think carefully about the axioms of expected utility theory. In particular, think about the independence axiom. As a reminder, the independence axiom is as follows:

Assuming that $X,Y,Z \in \mathbb{R}$ are lotteries and $p\in(0,1)$ is a generic probability:

$$X \succ Y, \implies pX + (1-p)Z \succ pY (1-p)Z$$

This axiom is most famously contradicted by the Allais Paradox.

Khaneman and Tversky introduced Prospect Theory, which in very basic terms says that humans think differently about losses than they do gains. Further, they point out that people weight small and large gains/losses different when making decisions. They posit that economic man's value function is defined on deviations from a reference point, that this value function is concave for gains and convex for losses, and that this value function is steeper for losses that for gains. Graphically:

Within that paper linking to prospect theory, you can read about the experiments of K&T. Several of their experiments are demonstrations of the Allais Paradox. And the reason that this contradicts expected utility theory (EUT) is very simple: they are showing that humans systematically violate one of the three axioms of EUT when making economic decisions.

The work of these men was seminal. However, they themselves have updated this original paper by introducing cumulative prospect theory. Other theorists and behavioral economists have noted the inability of prospect theory to explain behavioral regularities observed in the lab.