So, for example, someone at a gambling casino, who's lost a lot of money and

now is in the reign of losses, starts to think, maybe,

of taking a really big bet that might have the possibility of bringing them away so

they could close the day up instead of down.

So that people have a tendency to take risks in the domain of

losses to try to get them back, so that's the value function.

The other thing is the weighting function.

Now, on this axis we have the stated probability, now,

probabilities range from zero to one, and

so that's the actual probability of an event.

But on this axis we have the decision weight, which is a transformed,

psychologically transformed probability.

And you can see that they curve, this is the 45 degree line,

if people were completely rational,

they would use the actual probabilities in their calculations.

But they do not actually behave completely like that,

they tend to transform their weighting function, so

it looks like a curve with a slope less than one.

Also, it doesn't show, for very low probabilities and

very high probabilities, the line stops.

You notice that it doesn't tell you or,

by some versions, it drops to the zero or it jumps up to one.

So, what they are referring to,

let's talk about the fact that it doesn't go to zero or one.

What it means is for very low probabilities you have a tendency to

not appreciate them and, actually, often, to drop them to zero.

I'm not going to think about that.

If it's a probability of 10% of happening, you might worry about it, but

if it's 1%, I'm going to round that to 0 and not worry about it.

Similarly, on the upper end,

if something has a very high probability, people don't accept that hype,

they don't take that probability into account, and they round it to one.

So, I'll give you an example of the application of the weighting function.

And that is, it used to be that when you board an airplane they

had vending machines that offered you insurance against dying on this flight.

It's one flight, and they would charge you like $1 for an insurance policy.

And they would put the machine right there where you're boarding the airplane.

A lot of people would buy this because they're boarding an airplane and

they just get a little scared about this flight.

Well, actually, the probability of this flight crashing, what is it, one flight?

It's 1 in 10 million, right, so that $1 insurance should

give you a coverage of $10 million, but it [LAUGH] doesn't.

It gives you something very remote from that, and

people still buy it, why do they buy it?

It's because they're nervous.