Book Cover

Kahneman begins this chapter with a story about how Israelis reacted to the suicide bombings of the early 2000s.  While the bombings were rare, System 1 Thinking combined with an availability cascade caused an overstated impact on people’s behavior.  He goes further and points out that lotteries have the same basic pattern of behavioral impact. In both cases people overweight unlikely outcomes. The chapter is built on two premises: (more…)

Book Cover

 

Some characteristics influence the assessment of a situation more than others. We weight characteristics and attributes whether we are aware or not. When we are not aware we are defaulting to system 1 thinking which as we have read is very biased. This is one reason why formal decision-making processes codify the weighting of attributes to avoid personal biases.  (more…)

Book Cover

The chapters in Part 4 of Thinking Fast and Slow are relatively short and punchy, but the ideas aren’t small. I think these chapters are the most useful on a day-to-day basis.  Chapter 28 goes into depth on the concept of loss aversion. Loss aversion works because people evaluate outcomes as losses or gains, and losses loom larger than gains. If we consider the motives to avoid a loss or achieve gain, humans are driven to avoid losses than to achieve gains. Many of the cognitive biases we have explored earlier support the idea that our brains are wired to see threats above all else.  Threats include words (consider the reaction you get to words like transformation, transition, or change), they cause listeners to think of the possibility of loss which immediately invokes System 1 thinking. (more…)

Book Cover

Chapter 27 begins with a discussion of the classic indifference curve from Econ 101. The indifference curve shows the trade-off between two goods. In this case, Kahneman uses the trade-off between income and leisure to show how overly simple theories generate models that do not describe behavior outside the textbook. The problem that Kahneman points out is the basic indifference map doesn’t reflect context. This is the same point discussed in the chapter titled: Bernoulli‘s Error. Using the indifference curve of a salaried employee with two weeks of vacation. While the person has vacation time to use the trade-off would tend to follow the path of a typical indifference curve, however, when he/she used up 2 weeks of paid time off the slope changes to reflect the potential at one more unit of leisure might require trading off all income. As we have seen before context and starting point really matter. (more…)

Book Cover

This chapter formally introduces the Prospect Theory and talks about the difference between it and the Expected Utility Theory. When doing a little background research, prospect theory (part of his research on decision making under uncertainty) was noted as contributing to his winning the Nobel prize in economics. 

In Expected Utility Theory, a gain is assessed by comparing the calculated value of two states. The value delivered by a decision is calculated by multiplying each of the possible outcomes by the likelihood each outcome will occur and then summing all of those values.  If you have a 50% chance to make $500 and a 50% chance of breaking even, the value is $250. When the value is positive the theory would predict that humans would always accept the gamble. Kahneman and Tversky observed that real-life behavior often differed from the behavior predicted by this Expected Utility Theory because of the context in which the choice is made makes a difference.  Changing our example to a 50/50 chance of either making $500 or losing $400, Expected Utility Theory would predict that a rational economic human would accept the gamble. However, if the person being asked to make accept the gamble has a net worth of $1,000 they would naturally be more risk-averse because the potential loss would be perceived to be psychologically larger. (more…)

Book Cover

Kahneman opens the chapter by establishing the economic definition of a human as someone who is rational, selfish and whose tastes don’t change. This flies in the face of how a human is envisioned in psychological theory – not always rational, sometimes generous, and whose tastes change. I have always had trouble with rational human definition because I grew up in a family tied to the retail and wholesaling of clothing — at the very least I have direct evidence that people’s taste change which means part of the definition does not track. The idea that people act as a pure economic being is a tantalizing simplification when planning changes in an organization. Many changes agents try to sell the process change on a purely economic basis only to be shocked when there is resistance. (more…)

Book Cover

Optimism is both a great driver of progress and problematic.  In this chapter, Kahneman explores the concept and impact of optimism bias. This bias causes a person to believe that they are less likely to experience a negative event. For example, most software engineers believe that they have never met a problem they can’t solve — an unrealistic assessment in any complicated environment. Another typical example, most drivers think they are better than average — a statistical impossibility. A third example that we have commented on before, estimates chronically fall prey to optimism bias. The list of examples could go on nearly forever. This effect is driven by the propensity of individuals to exaggerate their abilities.     (more…)