Answer :
Prospect theory challenges the assumptions of rational economic agents in the neoclassical economic framework in several ways:
Reference Dependence: Prospect theory introduces the concept of reference dependence, which suggests that individuals evaluate outcomes based on changes from a reference point rather than absolute levels. This contradicts the neoclassical assumption of rational agents making decisions based on absolute values. Prospect theory recognizes that individuals' choices are influenced by gains and losses relative to a reference point, leading to different decision-making patterns.
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Final answer:
Prospect theory challenges the assumption of rationality in neoclassical economics by highlighting that individuals do not always make decisions rationally. It suggests that individuals are influenced by framing effects, loss aversion, and reference points. Prospect theory provides a more realistic framework for understanding decision-making under risk.
Explanation:
Prospect theory challenges the assumption of rationality in the neoclassical economic framework. In neoclassical economics, rational agents are assumed to make decisions based on expected utility theory, which assumes that individuals weigh options based on their probabilities and values. However, prospect theory suggests that individuals do not always make decisions rationally and are influenced by framing effects, loss aversion, and reference points.
For example, according to prospect theory, individuals tend to be risk-averse when facing gains but risk-seeking when facing losses. This challenges the idea that rational economic agents always make utility-maximizing decisions. Prospect theory also highlights the role of psychological factors in decision-making, such as the influence of emotions and cognitive biases.
Overall, prospect theory provides a more realistic framework for understanding decision-making under risk and challenges the assumptions of rationality that are central to neoclassical economics.
