What is Prospect Theory? (Easiest Explanation)

Prospect theory is a behavioral economic theory developed by Daniel Kahneman and Amos Tversky, which describes how individuals make decisions involving risk and uncertainty. It challenges the traditional expected utility theory by illustrating that people value potential losses and gains differently, often giving greater weight to losses than to equivalent gains. The theory posits that individuals evaluate outcomes relative to a reference point, leading to risk-averse behavior when facing potential gains and risk-seeking behavior when facing potential losses. Ultimately, prospect theory provides insights into various economic and psychological phenomena, such as consumer behavior and financial decision-making.