decision heuristics and biases

what is a heuristic

a simplifying strategy, rule of thumb or mental shortcut that people rely on when making judgements and decisions

what is the representativeness heuristic

instead of considering the true likelihood of an event, people use a degree of match/how well one thing resembled another to determine probability

describe the Linda problem

Linda is - single, outspoken, bright, philosophy major and concerned about injustice - likelihood she was a bank teller = 2.7, likelihood she was a bank teller and in feminist movement = 4.4 - statistically impossible - had no way of answering question so instead asked “how well does the description of Linda match the two options”

what biases come from representativeness heuristic

conjunction fallacy, insensitivity to base rates, misconception of chance, regression to mean

what is conjunction fallacy

ignores statistical proportions and instead relies on a story, description or stereotype to make judgements - e.g. Linda problem

what is an e.g. for insensitivity to sample size

marketing strategy - ‘four out of 5 dentists approve this message’ - only 5 people in sample = irrelevant

what is an e.g. for insensitivity to base rates

description of puzzle enjoyer - some told 70 were engineers, 30 lawyers and vice versa. most still thought the person being described was an engineer = ignored base rates of how many in sample

e.g. of misconception of chance

have 3 girls, thing have more of a chance of having boy when probability still 50/50

e.g. of regression to the mean

employee performs well - him and his boss expect similar performance next period - what happens when employees performance regresses back to mean - him and his boss make excuses for poorer performance

what is the availability heuristic

evaluating likelihood of events in terms of the ease with which past occurrences of those events happening can be brought to mind rather than determining true probability

e.g. of availability heuristic

stomach cancer = 42% said causes more deaths, motor accidents = 58% said causes more deaths - stomach cancer actually causes more

what biases come from availability heuristic

ease of recall and retrievability

e.g. of retrievability bias

search for employee candidates using social network - use most mentally and physically accessible source of candidates - results in people to similar to them - lack diversity

e.g. retrievability - employee behaviour

memorable behaviours of employees are recalled more easily and get overweighted - recent behaviour judged more heavily than behaviour earlier in year

what is the anchoring heuristic

makes estimates based on initial value and then adjusts from that value, often insufficiently

e.g. of anchoring heuristic

ghandhi age - older or younger than 140 when died - 96% younger, 4% said older, older or younger than 9 when died - 95% said older, 5% said younger

anchoring in advertising and marketing e.g.

show higher price first - normally £299, today £219

challenges to heuristics and biases

1. human reasoning is fluid and may not be ‘rational’ or ‘irrational’

2. hard to predict which heuristic will use in situations - found post hoc

3. structure - environment and task structure influences heuristics - context is important

what is the confirmation heuristic

thinking that involves looking for confirming evidenced - not disconfirming evidence - when testing ideas about what has, is or is going to happen

what biases come under the confirmation heuristic

confirmation trap, anchoring, hindsight and curse of knowledge

what is overconfidence

overconfidence in making accurate estimates, in abilities and overoptimism

e.g. of overconfidence in a business sense

overconfident in marketing strategy, approve large budget and product volume, strategy fails and left with excess inventory and high costs

how to counter overconfidence

add 20-25% more pessimism - test strategies under range of scenarios

what is mental accounting

inclination to categorise and treat money differently depending on where it comes from, where it is kept and how it is spent (Richard Thaler)

mental accounting e.g. in a business sense

cut costs on core business but spend freely on start ups

what is the endowment effect

desire to hang on to what you own - Thaler - Cornell logo mug - no more than $2.75 if don’t own, give for no less than $5.25

e.g. status quo bias in business sense

ceos reluctant to sell business - divestments can be major potential source of value creation but often neglected OR sticking with same supplier just because you always have, even if there is a better option

what is the sunk cost effect

throwing good money after bad

e.g. of sunk cost effect in business sense

loss aversion - rather spend another £10 mil on £110 mil project than write of £100 mil - after spent 100 mil 10 mil doesnt seem as bad

how to counter sunk cost effect

use gated funding, be prepared to kill strategy early

what is herding instinct

tend to lend too much money to same kind of borrowers at same time

e.g. of herding instinct in business sense

competitors release subscription based loyalty programme - then several other retailers release very similar programmes - fear of being left behind if dont follow trends

what is misestimating future hedonic states

bad at estimating how much pleasure/pain will feel if circumstances change

e.g. of misestimating future hedonic states

get offered role of manager - overestimate how happy you are etc, misestimate how much stress will feel

what is false consensus

leaders overestimate how many others share their views

e.g. false consensus in business sense

prepare to launch new app - thinks everyone will love it because they do