How To Do Exactly the Right Thing at All Possible Times or Nothing ____ ^ The Idea That Changed the World

E(u | p, X) = x X p(x)u(x)

E(u | p, X) = x X p(x)u(x) Expected Value = (Odds of Gain) X (Value of Gain)

(Odds of Gain) X (Value of Gain) If it comes up heads I’ll give you $10. Should you pay $4 to play? Yes! Expected Value = (Odds of Gain) X (Value of Gain) 1/2 X $10 = $5

(Odds of Gain) X (Value of Gain) Errors in Odds Errors in Value Expected Value = (Odds of Gain) X (Value of Gain) Idea is simple (if not, come out to a bar with me and bring your wallet). But life is not, and it is hard to apply this wise rule. People make two kinds of mistakes: Errors in WHAT will happen, and errors in how MUCH they’ll like it if it does.

(Odds of Gain) X (Value of Gain) Errors in Odds Errors in Odds Errors in Value Expected Value = (Odds of Gain) X (Value of Gain) Let me talk about errors in odds. Calculating odds is easy. 6 sides to a die, 2 sides to a coin, 52 cards in a deck. But that’s not how people do it, which is why Americans spend more $ on gambling than they spend on ALL other forms of entertainment combined.

Are there more dogs or pigs on leashes in Oxford? Errors in Odds Are there more dogs or pigs on leashes in Oxford? To understand how people DO figure odds, let’s talk about pigs. Are you more likely to see a dog or pig on a leash? You answer correctly because it is easier to bring dogs than pigs to mind. Your brain assumes that things that come to mind quickly are more frequent probable, which is often true.

Are there more 4-letter English words with R in the 3rd or 1st place? Errors in Odds Errors in Odds Are there more 4-letter English words with R in the 3rd or 1st place? _ _ R _ R _ _ _ sometimes things are memorable without being likely. RING, RANG, RUNG... BARE, FORT, PARK...

Errors in Odds Errors in Odds Cause Estimate Actual Tornado 564 90 Fireworks  160    6 Asthma   506    1886 Drowning   1684    7380 Per 200 million US residents per year

Errors in Odds Errors in Odds > > > > Cause       Estimate   Actual Tornado   564    90 Fireworks  160    6 Asthma   506    1886 Drowning   1684    7380 Per 200 million US residents per year > Overestimate what gets news, underestimate what doesn’t. > > >

Errors in Odds Errors in Odds Most dangerous thing is the bath tub. Irony: You’d think Heuristic would work well b/c you’d hear about common things more. But in a world where information is socially mediated, this works the other way around. As risks become more common and less newsworthy, we underestimate them. When they are rare and hence newsworthy, we overestimate them.

Errors in Odds Errors in Odds Lottery is a another good example. Why does anyone play when you have approximately the same odds if you flush your money? Economists call lotteries “a tax on stupidity.”

Errors in Odds Errors in Odds Many reasons…but ONE is that we see lots of winners and hence it is easy to imagine.

Errors in Odds Errors in Odds Would we play if for every interview with a winner we saw a hundred million interviews with losers? If each interview with 100 million people took only 30 sec, it would take 9.5 YEARS (w/o potty breaks) to see these interviews.

? Errors in Odds Errors in Odds 10 tickets $1 to play $20 if you win I can prove that the ease with which you can imagine winning changes your decision to play. Would you play this one? Yes, it is good bet.

Errors in Odds Errors in Odds 1/10 X $20 = $2

Errors in Odds Errors in Odds 1/10 X $20 = $2 But people won’t play this one, b/c it is so easy to imagine the other guy winning. 1/10 X $20 = $2

(Odds of Gain) X (Value of Gain) Errors in Value Errors in Odds Errors in Value Expected Value = (Odds of Gain) X (Value of Gain) Estimating odds is much easier than estimating value. How should we do it and how do we do it? How do we assign value? Is this worth $25? Answer: It depends on what else you can buy. On a flight to Tokyo, maybe. So the only rational question is “What else can I do with $25?” Is this Big Mac worth $25?

the Past instead of the Possible Errors in Value: Comparing with the Past But people don’t always compare opportunities with the possible because it is hard to do. Who can generate all the possibilities for $25 and then decide if they are better or worse. So they compare with the past. And $25 is unreasonable b/c you paid $3 yesterday. COMPARING WITH the Past instead of the Possible

Errors in Value: Comparing with the Past $150K $60K in Year 1 $50K in Year 2 $40K in Year 3 $135K This is irrational. People like jobs with increasing wages so much that they’ll take lower paying jobs. $35K in Year 1 $45K in Year 2 $55K in Year 3

Errors in Value: Comparing with the Past A $2000 Hawaiian vacation package is on sale for $1600. Would you buy it?

Errors in Value: Comparing with the Past A $2000 Hawaiian vacation package is on sale for $700. You think it over for a week, and by the time you get to the ticket agency, the best fares are gone and the package will now cost you $1500. Would you buy it?

Errors in Value: Comparing with the Past Yes $2000 $1600 No Pass up a good deal that was great but take a bad deal that was awful. $2000 $700 $1500

Errors in Value: Comparing with the Past You are on your way to the theatre. In your wallet you have a ticket for which you paid $20, and a $20 bill. When you arrive at the theatre you discover that you’ve somehow lost the ticket. Would you spend your remaining $20 on a ticket? No

Errors in Value: Comparing with the Past You are on your way to the theatre. In your wallet you have two $20 bills. When you arrive at the theatre you discover that you’ve somehow lost one of the bills. Would you spend your remaining $20 on a ticket? Yes

Errors in Value: Comparing with the Past The Lost Ticket The Lost Money X X Why? Because you associate the loss of a ticket to the play, you think that the price of the ticket has doubled. It once cost 20 and now costs 40 and you don’t want to pay twice for the same experience.

the Past instead of the Possible the Possible instead of the Past Errors in Value Comparing with the past causes problems. But even when we DO compare to the possible, we make errors . Why? COMPARING WITH the Past instead of the Possible COMPARING WITH the Possible instead of the Past

Errors in Value: Comparing with the Possible We all know that the value of something changes depending on what we compare it to.

Errors in Value: Comparing with the Possible Which wine would you buy? Most people don’t want the cheapest or most expensive so they take the middle. $8.00 $27.00 $33.00

Errors in Value: Comparing with the Possible That’s why retailers will keep unaffordable items on the shelf. The act of comparing changes value. The reason this is a problem is that the comparisons we make when we are PREDICTING VALUE are not the ones we make WHEN WE ARE EXPERIENCING VALUE. When you get the wine home, it won’t matter what was on the shelf next to it. $8.00 $27.00 $33.00 $51.00

Errors in Value: Comparing with the Possible People don’t understand this

Errors in Value: Comparing with the Possible You want to buy a car stereo. The dealer near your house sells it for $200, but if you drive across town, you can get it for $100. Would you drive to get 50% off (saving $100)? Yes Problem of shifting comparisons explains this.

Errors in Value: Comparing with the Possible You want to buy a car with a stereo. The dealer near your house sells it for $31,000, but if you drive across town, you can get it for $30,900. Would you drive to get .003% off (saving $100)? No This drive economists crazy because dollars don’t know where they came from. This is why people who don’t attend to retirement still clip toothpaste coupons. The problem is that in each case you compare the saved money to the spent money, which is NOT what you’ll do when you spend the saved money.

Errors in Value: Comparing with the Possible We’ve all had this happen. You meet a couple in France and become friends because compared to the French they are nice. But then you get them home and find that compared to your old friends, they are dull and you dislike them enough to qualify for French citizenship. You are in the store and you can hear the difference btw the boxy and sleek speakers, but this is a difference you’ll never hear again, though you will always compare the boxy speakers to your otherwise sleek and now-ruined décor.

Errors in Value: Comparing with the Possible Comparing to the posisible is hard when the alternatives exist in space A B C D

Errors in Value: Comparing with the Possible But it is even more difficult when they are arrayed over time TODAY TOMORROW NEXT WEEK NEXT YEAR

Errors in Value: Comparing with the Possible $60 NOW $50 NOW OR How do we make choices over time? We use two rules. Consider 2 very easy problems. This is a 1-item IQ test. Problem #1

Errors in Value: Comparing with the Possible More is better than less  $60 NOW $50 NOW You take $60 b/c more is better than less. Problem #1

Errors in Value: Comparing with the Possible $60 In 1 month $60 NOW OR Problem #2

Errors in Value: Comparing with the Possible Now is better than later  $60 In 1 month $60 NOW Even easier! Problem #2

Problem #3 $60 $50 NOW Errors in Value: Comparing with the Possible Now is better than later More is better than less BUT $60 In 1 month $50 NOW OR But what happens when these two obvious rules conflict? This is a common dilemma. Earn money now or go to college and earn more later. Snack now or eat a good dinner later? Spend now or invest and have more to spend later? Problem #3

 Problem #3 $60 $50 NOW Errors in Value: Comparing with the Possible Now is better than later More is better than less  $60 In 1 month $50 NOW Impatience People are grasshoppers! If you demand an extra 5% to wait a year, you are demanding 5% interest. What do people actually demand? Hundreds and thousands of percent! Problem #3

 $60 $50 NOW $50 $60 Errors in Value: Comparing with the Possible Now is better than later More is better than less  $60 In 1 month $50 NOW Impatience But impatience isn’t the problem – dynamic inconsistency is! $50 In 12 months $60 In 13 months OR

  $60 $50 NOW $50 $60 Errors in Value: Comparing with the Possible Now is better than later More is better than less  $60 In 1 month $50 NOW Impatience But impatience isn’t the problem – dynamic inconsistency is!  $50 In 12 months $60 In 13 months Patience

Errors in Value: Comparing with the Possible Impatience Patience This illustrates it. But why does it happen? Comparison! 30 Days 30 Days

Errors in Value: Comparing with the Possible Consider the perceptual illusion that differences between big and small things get smaller as they move away from you.

Illusions of Spatial Perspective Errors in Value: Comparing with the Possible Illusions of Spatial Perspective Notice fireman is taller at each point but difference gets smaller. 1 vs 20 feet is enormous, but 2000 vs 20020 is not. As seen from  1 ft 21 ft 2000 ft 2021 ft

Illusions of Spatial Perspective Errors in Value: Comparing with the Possible Illusions of Spatial Perspective Because 20 feet makes a bigger difference when it is close, it can actually reverse their heights! As seen from  1 ft 21 ft 2000 ft 2021 ft 20 Feet 20 Feet

Illusions of Temporal Perspective Errors in Value: Comparing with the Possible Illusions of Temporal Perspective As Plato noted, what Size is to space, value is to time! Notice that you prefer $60 to $50 in every time period, but that this preference gets weaker as the period gets further away. Both “more better than less” and “now better than later” are preserved. As seen  from

Illusions of Temporal Perspective Errors in Value: Comparing with the Possible Illusions of Temporal Perspective 30 days of waiting makes a bigger difference when it is near – it can actually reverse their value. The static comparison was easy. At every point in time you pick the larger value, even though your preference is weaker. But when we compare across time periods, trouble! Notice that this implies that as the 2nd period approaches, you will change your mind and regret your patient decision. As seen  from 30 Days 30 Days

If we’re so stupid, then how did we get to the moon? Conclusion If we’re so stupid, then how did we get to the moon? If we are so dumb then how did we get to the moon? Our brains were evolved for a world very different than this one – a world in which people lived in small groups, never met anyone different than themselves, and lived short lives in which eating and mating TODAY were not just the highest priorities, but the ONLY priorities. Bernoulli’s equation tells us how to think about a world for which nature did not design us. We are the only species on this planet ever to have held its own fate in its hands. We have no significant predators and we are the masters of our physical environment . The only things that can destroy us are our own poor decisions. If we are not here in 10,000 years, it will be because we could not take advantage of Bernoulli’s great idea -- because we underestimated the odds of our future pains, and overestimated the value of our present pleasures.