Over the Christmas period I like to accumulate books. Mostly because the holiday period generally means more free time and boredom can become an issue. One of the books I bought this year was Stephen Hawking’s A Brief History of Time. While physics isn’t my own discipline, I must say that I enjoyed the bits I understood. Particularly when he starts explaining what a good theory is. I found this interesting because I never really sat down and tried to think about what a theory is before€. I’m just used to discussing them with people who also have some vague kind of understanding of what they are as well. But it is an important thing to consider. I mean what’s the difference between a theory and a concept? or a theory and a model?
Hawking says that an essential element to a good theory is that it needs to predict things that happen. This is simple but serves as a perfect explanation for what a theory is. It seems to work as an explanation as well when we think of it relating to theories. If we take the theory of Einstein’s general theory of relativity for example it provides us with the geometric theory of gravitation which accurately predicts how gravity works. Now since this is Music Economics not Music Physics I’m going to provide an example from my own field.
Let’s take the expected utility theory. This theory attempts to explain people’s decision making in situations of risk. It essentially tries to say that people make decisions in accordance with their preferences of outcome. For example, if you are asked the following question:
Which option would you prefer?
A) A sure bet of winning €100
B) A 50% chance of winning €200 or winning €0
If you value a definite €100 more than a 50:50 shot between €200 and €0, then you should chose option A and not option B. If the expected utility theory is a good theory then when people have to make decisions like this, they should do so in accordance with their own preference of outcome. Their decisions should also remain consistent when faced with similar questions regarding losses instead of gains. For example, if they were asked the following question:
Which option would you prefer?
A) A guaranteed loss of €100
B) A 50% chance of losing €200 or losing €0
Even though the question here is in terms of losses instead of gains, they preference of individuals should stay the same. If in the first question they pick option A, that means they prefer a sure €100 to a 50:50 shot of an extra €100, then this shows they place a higher level on the €100 than a potential additional €100. So, when they are asked the second question they should answer option A again because they would prefer definitely only losing €100 to potentially losing €200. If they answer option A then the expected utility theory is a good theory.
However, unfortunately for the expected utility theory psychologists Amos Tversky and Daniel Kahneman publishes a paper which proved that people are not this consistent in their decision making and proposed a more accurate theory for individual decision making known as prospect theory. They basically found that when faced with gains, individuals are more risk averse – they take the definite €100 – whereas when they are faced with the same decision with regard to a loss they are willing to take a chance on the risky option – A 50% chance of losing €200 or losing €0 – Because prospect theory has been shown to more accurately predict what happens when people make decisions it is a better theory.
By Daragh O’Leary