Final answer:
Prospect theory posits that the utility of a lottery is affected by the psychological value individuals place on potential gains and losses, not just the expected outcomes.
Step-by-step explanation:
According to prospect theory, the utility of a lottery with outcome x (the number of successes) and probability p (the estimated probability of successes) is not simply the product of x and p. Instead, prospect theory suggests that individuals value gains and losses differently, leading to an asymmetric value function where the utility of a gain is usually less impactful than the disutility of a commensurate loss.
This theory diverges from the traditional expected utility theory in that it takes into account the psychological impact of gains and losses. When evaluating the utility of a lottery according to prospect theory, individuals are assumed to make decisions based on the potential value of losses and gains rather than the final outcome, and they tend to overweight small probabilities and underweight large probabilities, which can lead to risk-averse or risk-seeking behaviors depending on the context.