Prospect Theory, introduced by psychologists Daniel Kahneman and Amos Tversky in 1979, explores decision-making under risk and uncertainty. It is a psychology theory that suggests that individuals prioritize avoiding losses over seeking gains, exhibiting characteristics like certainty preference, discounting small probabilities, relative positioning, and loss aversion. The theory involves two phases: editing (framing effects) and…
What is Screening? Screening refers to a strategy that is used to combat adverse selection by filtering out false information and retaining only the true information. Screening is used in contemporary markets where the products being released into the market are getting increasingly complex for an ordinary consumer to comprehend. For example, in the auto…
What is Binomial Distribution? Binomial distribution is a common probability distribution that models the probability of obtaining one of two outcomes under a given number of parameters. It summarizes the number of trials when each trial has the same chance of attaining one specific outcome. The value of a binomial is obtained by multiplying the…
What is the Manufacturer’s Suggested Retail Price (MSRP)? The manufacturer’s suggested retail price (MSRP) is the price at which the manufacturer recommends retailers sell its product. The MSRP generally reflects all the manufacturing and selling costs associated with a product. It is also known as the list price, or the recommended retail price (RRP), or the…
What is Clustering Illusion? Clustering illusion refers to a cognitive bias in behavioral finance in which an investor observes patterns in what are actually random events. In other words, clustering illusion bias is the bias that arises from seeing a trend in random events that occur in clusters that are actually random events. The clustering…
What is a Vickrey Auction? A Vickrey auction is a sealed-bid auction where bidders submit bids without knowing the bids of other people. However, as opposed to other sealed-bid auctions, the price paid is the second-highest bid price and not the winning bid price. The Vickrey auction was named after William Vickrey, a Canadian who…
What is Maslow’s Hierarchy of Needs? Maslow’s hierarchy of needs is a theory of psychology explaining human motivation based on the pursuit of different levels of needs. The theory states that humans are motivated to fulfill their needs in a hierarchical order. This order begins with the most basic needs before moving on to more…
What is Operating Risk? Operating risk is the risk related to a company’s cost structure. More specifically, it is the risk the company faces due to the level of fixed costs in its operations. Together with sales risk, operating risk is one of the two components of business risk. Operating Risk as a Component of Business…
What are the Drags and Pulls on Liquidity? The drags and pulls on liquidity are the factors that negatively affect a company’s cash inflows and outflows by determining a deterioration in its liquidity position. A drag on liquidity exists when cash inflows lag, for example, because a company is facing trouble with the collection of…
