decision making mistakes (chapter 9)

Misperceptions/Misunderstanding opportunity costs

1.  People tend to ignore opportunity costs (what theyre giving up) when they are nonmonetary. Sunk cost fallacy. Example: if you go to a “free concert” but skip studying for an exam, you think the concert is free but at the cost of a lower exam score. 

Overconfidence

we tend to think we are better/know more than we actually do

Unrealistic expectations about future behavior

people are too optimistic about future behavior. Example: you buy a gym membership thinking “ill go everyday” but in reality you stop going after a week.

Unrealistic expectations about future behavior - System 1

acting on impulse “ill study later, its fine” fast thinking, quick decisions.

Unrealistic expectations about future behavior - System 2

slow, deliberate, consious calculations (example: planning your schedule, calculating time needed to complete a task)

Counting dollars unequally(mental counting)

treating money differently depending on where it comes from, therefore, some money is worth more than other. Example: you get $100 gift card->you spend it quickly. But if you got $100 on your paycheck, u usually save it because its hrd worked money. You assign value to money depending on how you got it.

Loss aversion

Losses feel worse than wins feel good. You avoid taking risks of a loss even if they are worth it. Example: losing $50 feels TERRIBLE. But gaining $50 feels just okay.

Example: Alex is invested in the stock of Nortel. However, Nortel has been in a steady decline, even though all signs point to the fact that Nortel will likely go bankrupt. Alex holds onto his stocks, unwilling to sell unless he makes back at least the money he invested

Framing bias

Tendency to make a choice based on how the choices are presented. Example: a thing being $0.99 is more attractive than $1.00 and you buy based off that.

Fear of missing out (FOMO)

you do something because someone else made money from it. Example: buying a stock bc everyone made money from it last year. However past does not equal future.

Status quo bias

tendency to avoid making decisions to avoid change. Example: staying with the same phone plan even if better options exist because changing feels like effort.

Example: a researcher faces decision paralysis every time a big question is posed to her. Whenever her boss asks what project she wants to work on, she always says she is indifferent, so eventually her boss stops asking her and assigns her whatever he wants.

Bounded rationality (reasons people might rationally choose a worse payoff)

choosing a “good enough” thing over one that has the best pay off): when picking a restaurant you dont look at every single option in the menu, you find one that is good enough and go there. Finding the perfect one takes too much time and effort.

Risk aversion (reason people might rationally choose a worse payoff)

(avoiding losses - people prefer safer options): someone would choose $100 for sure instead a 50% chance of getting $200. Or people pay for health insurance in case anything ever happens.

Four reasons why poeple might choose a worse payoff

1. Concerns of fairness

2. Nonmonetary Rewards

3. Bounded rationality

4. Risk aversion

Economic profit > zero

good decision if… (economic profit…)

Economic profit = zero

normal profit if… (economic profit…)

Economic profit < zero

switch choices to a better alternative