Decision Theory: Acts, State of Nature event

Decision theory (or the theory of choice not to be confused with choice theory) is the study of an agent’s choices. Decision theory can be broken into two branches: normative decision theory, which analyzes the outcomes of decisions or determines the optimal decisions given constraints and assumptions, and descriptive decision theory, which analyzes how agents actually make the decisions they do.

Decision theory is closely related to the field of game theory and is an interdisciplinary topic, studied by economists, statisticians, psychologists, biologists, political and other social scientists, philosophers, and computer scientists.

Empirical applications of this rich theory are usually done with the help of statistical and econometric methods.

Normative and descriptive

Normative decision theory is concerned with identification of optimal decisions where optimality is often determined by considering an ideal decision maker who is able to calculate with perfect accuracy and is in some sense fully rational. The practical application of this prescriptive approach (how people ought to make decisions) is called decision analysis and is aimed at finding tools, methodologies, and software (decision support systems) to help people make better decisions.

In contrast, positive or descriptive decision theory is concerned with describing observed behaviors often under the assumption that the decision-making agents are behaving under some consistent rules. These rules may, for instance, have a procedural framework (e.g. Amos Tversky’s elimination by aspects model) or an axiomatic framework (e.g. stochastic transitivity axioms), reconciling the Von Neumann-Morgenstern axioms with behavioral violations of the expected utility hypothesis, or they may explicitly give a functional form for time-inconsistent utility functions (e.g. Laibson’s quasi-hyperbolic discounting).

The prescriptions or predictions about behavior that positive decision theory produces allow for further tests of the kind of decision-making that occurs in practice. In recent decades, there has also been increasing interest in what is sometimes called “behavioral decision theory” and contributing to a re-evaluation of what useful decision-making requires.