Chapter 9 - Judgement and Decision Making

Focus Errors

Systematic biases that lead to inaccurate or distorted judgments and decision

Normative Approach

how we ought to think

Descriptive Approach

how we actually do think

Kahneman (2011) book: Thinking, Fast and Slow

Human thinkers operate in two different reasoning modes:

• Heuristic Mode (System 1): Thinking Fast (e.g., where to have lunch)

• Analytic Mode (System 2): Thinking Slow (e.g., where to go to college)

Judgment

The human ability to infer, estimate, and predict the character of unknown events. Often involves making estimates of the likelihood of an event (probability)

In almost all judgment situations we do not have…

all the information to reach an accurate conclusion. Even if we did, we don’t have the computational power required to combine the information

So often we make educated guesses using

heuristics

Heuristics

“Rules of thumb” that are likely to provide the correct answer to a problem (Fast, cognitively easy, typically right)

Representativeness Heuristic

A mental shortcut people use to make quick judgments/estimates by comparing a new situation/object to a prototype or stereotype they already have in mind.

• Example: Family has 6 kids, which birth order more likely:

  • BBGBGG or BBBGGG

• Example: Roll a die twice, which is more likely?

  • a ⁙ then a • • or a • then a •

• Sample judged as more likely if it resembles prototype or expectation

Powerful heuristic overrides other important information such as overshadowing…

general statistical principles such as base rates!

Kahneman and Tversky

studied influence of representativeness heuristic using stereotypes and identified many heuristics that humans rely on.

• Susan is very shy and withdrawn, invariably helpful, but with little interest in people, or in the world of reality. A meek and tidy soul, she has a need for order and structure, and a passion for detail.

• Is Susan most likely to be a: librarian, lawyer, or a teacher?

• Is Jane most likely to be a: librarian, lawyer, or a teacher?

Conjunction Fallacy

When people think a combination of two events is more likely than just one of those events alone.

Conjunction Fallacy -  Kahneman and Tversky (1983)

• Presented participants with this description:

  • Linda is 31 years old; she’s single, outspoken, and very bright. She majored in philosophy. As a student, she was deeply consumed with issues of discrimination and social justice, and participated in anti-nuclear demonstrations.

• Asked them to estimate the likelihood of various facts about Linda

• Key comparison:

• Likelihood of Linda being

• (a) a bank teller

• (b) a bank teller and active in the feminist movement

In Kahneman and Tversky (1983) what rule of probability did participants ignore?

That the probability of two things happening together (A and B) is always less than or equal to just one happening (A).

Law of sample size

smaller sample sizes produce more variance

Gambler’s fallacy

Faulty reasoning that past events in a sequence affect the likelihood of future events

• Failure to understand the independence of events

• Previous outcomes do not have impact on future outcomes

  • Ex: Roulette Wheel

Availability Heuristic

A mental shortcut where people judge something as more frequent or likely if examples come easily to mind. (Memory factors affect this).

Availability

We tend to worry about the wrong things based on media exposure.

Anchoring & Adjustment heuristic

Mental shortcut where we start with an initial estimate (anchor) and adjust from it.

What did Tversky & Kahneman (1974) show about anchoring?

People anchor on the random number, even when it’s clearly unrelated.

• Wheel rigged to stop at 10 - Subjects’ average estimate = 25%For other half of the subjects:

• Wheel rigged to stop at 65 - Subjects’ average estimate = 45%

Anchoring matters because…

we lack a strong internal sense of value or price.

Anchoring with Dummy Options

People judge value relative to other options, not absolutely. Dummy options (like an overpriced or less desirable choice) can anchor our judgment.

Ariely (2008)

 Example with The Economist subscriptions—adding a dummy option changed what people chose.

Intuitive Thinking

Unconscious thought can be useful for complex decisions that involve multiple factors.

Deliberation-without-attention effect

Where you consciously make a decision, but unconscious processes help you arrive at it

• Sleep on it

• Take a few days before arriving at a decision

Less-is-more effect

where too much deliberation devoted to a problem leads to less accurate, sensible, or satisfying decisions

__________ (good enough) are typically happier with decisions than __________ (best possible)

1. Satisficers

2. optimizers

Recognition Heuristic - Gigerenzer & Hoffrage (1995)

Asked German and American College students which have a larger population in San Diego or San Antonio. Americans were 67% correct and Germans were 100% correct.  Germans – used Recognition Heuristic as they had heard of San Diego but not San Antonio

Goldstein & Gigerenzer (2002)

American college students presented with pairs of German cities. When given recognition test they 

• Identified pairs in which Recognition Heuristic could be used (recognized one but not the other)

• Selection in direction of Recognition Heuristic 90% of the time

One-Clever-Cue

Pick one feature to use for decision

• Need to stop and get gas on a road trip

• Pick gas station with lowest price

Fluency

Choose option recognized first or more easily

Take-the-Best Heuristic

A decision-making shortcut using a fast-and-frugal search through cues ranked by importance

1. Search Rule

2. Stopping Rule

3. Decision Rule

Search Rule

Compare cues in order of assumed validity (e.g., for choosing the larger city: recognition, sports teams, capital, university).

Stopping Rule

Stop at the first cue that clearly distinguishes between options.

Decision Rule

Choose the option favored by that cue

•  Example: Used in military decision trees (e.g., U.S. checkpoints in Afghanistan).

Models of Decision making - Normative Models

What people should do

• Optimal decisions

• Prescriptive – guides for decision making

Models of Decision making - Descriptive models

What people actually do

Normative models

maximize gain, minimize loss

Expected Value Theory

person should: Maximize anticipated “payoff” and Minimize anticipated “loss”

How do you evaluate choices using Expected Value?

Calculate the sum of (value of possible outcomes x probability)

• Choice A: Probability of .5 that you win $50

  • Choice A: (.5 x $50) + (.5 x $0) = $25

• Choice B: Probability of .75 that you win $25

  • Choice B: (.75 x $25) + (.25 x $0) = $18.75

Should you buy a Power Ball lottery ticket for a $50 million jackpot?

• Choice A: Don’t buy ticket Probability of 1.0 that you still have $2

• Choice B: Buy ticket Probability of .000000005 you win $50 million

  • Probability of .999999995 you now have $0

ANSWER: Choice A expected Value: $2.00 - Choice B expected Value: $.29

Utility

benefit gained from each outcome

Utility depends on…

individual goals, context, etc.

Expected Utility Theory

Utility may not equal value. Different people may put different subjective values on the same amount.

• Utility of $20 bill

  • Student

  • Tiger Woods

    • Something to sign an autograph on

What did Kahneman and Tversky (1984) observe about decision-making?

They observed that people often violated expected utility theory when making decisions involving risk.

Should you take the bet in Kahneman & Tversky’s example?

• Take the Bet: Expected value = (0.5 x $15) + (0.5 x -$10) = $2.50 gain

• Decline the Bet: Expected value = $0 (no gain)

Kahneman and Tversky (1984) - Prospect Theory

A theory that states that people evaluate new states as either gains or losses compared to a reference point, with a stronger emotional reaction to losses.

What is "loss aversion" in Prospect Theory?

Loss aversion refers to the idea that people are more sensitive to potential losses than to potential gains of the same magnitude.

What is an example that illustrates loss aversion in Prospect Theory?

The example of a $5 bill falling into a storm sewer: People would feel much more upset about losing $5 than they would feel happy about finding $5.

Framing Effect: Risk Aversion

People facing gain -- risk averse

• Avoid risk -- protect what they have

• Take the sure thing

Framing Effect: Risk Seeking

People facing loss -- risk seeking

• Assume more risk to try to avoid loss

• Willing to take chance

Tversky & Kahneman (1981): Outbreak problem

The study explored how different framing of choices (positive vs. negative) influenced decision-making during a disease outbreak expected to kill 600 people.

What were the results for "Positive Framing" (saving lives) of Tversky & Kahneman (1981) Outbreak Problem?

72% of participants chose Option A, showing a preference for the non risky choice (risk aversion)

What were the results for "Negative Framing" (people dying) of Tversky & Kahneman (1981) Outbreak Problem?

 78% of participants chose Program B, showing a preference for the risky choice (risk seeking).

What did the results of the Outbreak problem show about decision-making?

The framing of choices (positive vs. negative) influenced people's preferences for risk, with a shift from risk aversion to risk seeking depending on how the options were framed.

Sunk Costs

cost that has already been incurred and is unrecoverable (Should be excluded from decision making process)

Arkes and Blumer (1985)

 Participants were to imagine that they had purchased tickets for two different ski trips: 1.) Wisconsin for $50, or 2.) Michigan for $100

• Wisconsin was preferable because more enjoyable (better snow conditions)

• Complication: two trips were on the same weekend and tickets are nonrefundable

• RESULTS: Most participants opted for Michigan even though Wisconsin was touted as being more enjoyable.

• Psychological accounting: not going to Michigan would “waste” more money. However, these costs were already “sunk”. The $150 had already been spent – should do what you would enjoy more or benefit from more

Status Quo Bias

preference for the current state of affairs. Even if change is advantageous, people try to avoid transaction cost (time, effort, and resources needed for change)

Optimal defaults

Automatically place people into options that have the greatest benefit.

• Ex: Organ donation rates lower in opt-in countries vs. opt-out countries

• Ex: Automatically enrolling new employees in retirement program

You would most likely use _______ when hiring someone for a job.

System 2 thinking

An example of the conjunction fallacy would be

believing it is more likely a pop star plays the violin and guitar as opposed to just the violin

Which of the following is an example of the representativeness heuristic influencing behavior?

Double checking your receipt at the grocery store because it came out to be $20.00 exactly

An example of the gambler's fallacy would be believing that

a coin flip is more likely to be heads after the previous five flips were tails.

An example of availability heuristics is that people overestimate their personal contributions for group tasks because

it is easier to remember personal contributions than contributions made by others.

A coin is flipped twice.  If it comes up heads both times (P = .25), you win $20.  If it comes up heads once (P = .50), you win $10.  If it comes up tails both times (P = .25), you win $0).  What is the expected value?

$10.00

Imagine that you didn't know how to answer the previous question and you were guessing. The first option is a low value ($2.50) that you assume can't be correct.  However, it biases you to choose $5.00.  This would be an example of:

Anchoring

Why do most people feel worse about losing $10 on a bet than gaining $10 on bet?

People overvalue losses compared to gains of the same amount.

How does framing affect decision making?

Decisions are dependent on whether a problem activates the concept of a gain or a loss

Which of the following is an example of an optimal default?

Being automatically enrolled in a healthcare plan after being hired for a job