What is the basis of the prospect theory developed by Kahneman and Tversky?
The prospect theory developed by Kahneman and Tversky identifies individual choice under conditions of uncertainty. Over time, the application of the prospect theory to consumer decision making has been studied under varied conditions and situations. The theory suggests that decision makers assess their options on two non-linear dimensions:
- A value function which plots out the value of the outcome
- A probability function that outlines the likelihood of the outcome occurring
The main decisive aspect is the decision maker’s (participant’s) reference point as the alternatives are consequential to the comparison of each outcome with its deviation from the reference point. The reference point was used to identify absolute zero, and each alternative was identified as a gain or a loss from the reference point. The assessment step concluded with the participant choosing the option that has the greatest value. Subsequently, it is theorized that reference points performed a similar part in participant evaluation of corporation behavior and in the following forming of participants’ perceptions and decision making, it is essential to understand how participants form reference points and how to identify them.
The formation of reference points began with the consumer’s (participant’s) learned values and moral standards established in the early stages of life. Reference points are also ever-changing and dynamic depending on the context. In the case of business ethics and reference point formation, the participant initially established their first reference point (i.e., the participant’s moral beliefs and values on sweatshop labor) which is constantly changing due to environmental factors such as the consumption of new information. This continues to go on up until the moment comes for the participant to a decision between the products of two or more companies. When making this decision, the participant evaluated the alternative options, founded on their current reference point and decided the chose that has the greatest gain from the final reference point. Therefore, participants’ reference points are essential in understanding whether CSR effects decision making. This theory was used to help identify the following themes in this study.