13 - Decision Making

rational decision making

process of choosing a a course of action for a number of different alternatives, being consistent and value-maximized

utility function

aim to make the best choice from the options we perceive to have

liberty

required to maximize our utility and benefit, while minimizing our costs for our goals

rational decision making model

provides us a sequential and logical process meant to reach a rational choice to create an optimized decision.

the assumptions of the rational decision making model

problem clarity, known options, clear preferences, constant preferences, no time or cost constraints, and maximum payoff

rational decision making model limitations

people don’t always act rationally, decisions sometimes need to be made on the spot, choices can be confusing, and it does not consider long-term decision making

actual decision making factors

bounded rationality, satisficing, intuition, and judgement shortcuts

bounded rationality

limitations on being able to interpret, process, and act on information. we are also limited by internal and external factors

satisficing

the first acceptable option over the optimal one, so instead of maximizing utility we look for good enough solutions

intuition

non-conscious process created from distilled experience that make quick decisions. one of the least rational tools to help us decide stuff.

instinct

innate, hardwired tendency toward a certain behaviour, which are automatic reactions to environmental stimuli and cannot be repressed. occurs in everyone

plato and intuition

distant memory embedded in our soul

descartes and intuition

ancient body of knowledge we cannot access before we engage in deep rational thinking processes

david hume and intuition

allows us to identify relations between time, space, and causes

attribution theory

when we evaluate human behaviour, it is either internally caused or externally caused

fundamental attribution error

we underestimate the influence of external factors and overestimate the influence of internal factors when carrying out perception

self-serving bias

tendency to attribute our own success to internal causation, and failure to external factors

heruistics

mental shortcuts that ease the cognitive load of deciding, ex. rule of thumb

what do we often do when deciding?

take shortcuts and have biases

overconfidence bias

believing too much in our ability to make good decisions. the weaker this is, the more likely we overestimate performance/ability

dunnig kruger effect

when people are more knowledgeable they are less confident. you need a certain level of knowledge to realize how bad you are

confirmation bias

using facts that only support your decision. we become prisoners of our own assumptions

availability bias

emphasizing info that is most readily at hand, especially if recent or vivid

randomness error

tendency to believe we can predict the outcome of random events, ex. superstitions

risk premium formula

expected value - certainty equivalent

risk aversion

preferring a guarantee over a risky outcome

loss aversion

risk of loss is stronger than the potential gain, so people avoid it

prospect theory

people feel more psychological pain when they lose something than they feel pleasure when they gain something

sunk cost fallacy

tendency to persist in an activity due to the already invested effort, time, and money

sunk costs

permanent losses of resources incurred as a result of a decision

irrational escalation of commitment

tendency to continue to commit to something failing or wrong, unwilling to admit mistake

what is the difference between sunk cost and escalation of commitment?

former occurs due to investment of time and money, and latter occurs from cognitive effort and social commitment

anchoring bias

using early information as the basis for making a judgement

framing

the ways which we structure our situation impacts our decision making

planning fallacy

tendency for us to underestimate the duration of time to complete something, even if it contradicts our experiences. when we predict our own, we show an optimistic bias, and when others predict it, they show a pessimistic bias

what are potential explanations for the planning fallacy?

not considering experience, wishful thinking, self-serving bias, and framing

why is planning fallacy important to recognize and avoid?

this may lead us to make decisions ignoring realistic estimates of the demands of the task, downplaying the elements of risk and luck.

hindsight bias

tendency to believe we could accurately predict something even if not guaranteed. can increase performance and confidence, but it can also reduce our ability to think rationally and learn from the past

how can we rationally think?

focus on goals and eliminate options not aligned with them, look for disconfirming information, don’t create meaning, and increase our options