5 MARCH 2015 TOK LECTURE TRUTH: TNML

ECONOMICS  ECONOMISTS HAVE A VERY SHAKY RELATIONSHIP WITH TRUTH.  AT THE HEART OF THE FINANCIAL CRISIS OF 2008 WAS THE VIEW THAT ECONOMISTS HAD ACHIEVED AN UNDERSTANDING OF THE WAY MARKETS WORKED AND COULD STILL PREDICT UNDER THE CONDITIONS OF UNCERTAINTY.

TRUTH IT WASN’T TRUE.

2008  THERE WAS A DISASTER. AND NOW THE TRUTH OF ECONOMIC THEORY IS GREATLY DOUBTED.

KNIGHTIAN UNCERTAINTY From Wikipedia, the free encyclopedia In economics, Knightian uncertainty is risk that is immeasurable, not possible to calculate.economics Knightian uncertainty is named after University of Chicago economist Frank Knight (1885– 1972), who distinguished risk and uncertainty in his work Risk, Uncertainty, and Profit:University of ChicagoFrank Knightriskuncertainty "Uncertainty must be taken in a sense radically distinct from the familiar notion of Risk, from which it has never been properly separated.... The essential fact is that 'risk' means in some cases a quantity susceptible of measurement, while at other times it is something distinctly not of this character; and there are far-reaching and crucial differences in the bearings of the phenomena depending on which of the two is really present and operating.... It will appear that a measurable uncertainty, or 'risk' proper, as we shall use the term, is so far different from an unmeasurable one that it is not in effect an uncertainty at all."

LEARNING 1  RISK ISN’T THE SAME AS UNCERTAINTY. WE CAN MEASURE RISK AND THEREFORE PROBABLY CONTROL FOR IT AND PREDICT DESPITE RISK. UNCERTAINTY IS DIFFERENT.

ARE OUTCOMES COLLECTIVELY RATIONAL?  EVER SINCE KEYNES DESCRIBED THE STOCK MARKETS AS DETERMINED BY THE ‘ANIMAL SPIRITS’ OF INVESTORS THERE HAS BEEN DOUBT ABOUT THE MOTIVES IN THE MARKET.  THE PERFECT MARKET HYPOTHESIS – THAT MARKETS SHOULD REFLECT REAL VALUES IF PEOPLE ARE RATIONAL FOR THE TWO REASONS ABOVE, WAS SEEN CATASTROPHICALLY TO FAIL IN 2008.

LEARNING 2  THE IDEA THAT MARKETS REFLECT TRUE VALUE IS KNOWN AS THE ‘PERFECT MARKET HYPOTHESIS’

BEAUTY CONTESTS  THE CONTESTANTS HAD TO PICK THE ‘ONE MOST LIKELY TO CATCH THE FANCY OF OTHER COMPETITORS’.

KEYNES EXPLAINS BEAUTY CONTESTS  “IT IS NOT A CASE OF CHOOSING THOSE [FACES] THAT, TO THE BEST OF ONE'S JUDGMENT, ARE REALLY THE PRETTIEST, NOR EVEN THOSE THAT AVERAGE OPINION GENUINELY THINKS THE PRETTIEST. WE HAVE REACHED THE THIRD DEGREE WHERE WE DEVOTE OUR INTELLIGENCES TO ANTICIPATING WHAT AVERAGE OPINION EXPECTS THE AVERAGE OPINION TO BE. AND THERE ARE SOME, I BELIEVE, WHO PRACTICE THE FOURTH, FIFTH AND HIGHER DEGREES.”  (KEYNES, GENERAL THEORY OF EMPLOYMENT INTEREST AND MONEY, 1936).

QUESTION 1 1. EVERYONE PICK A NUMBER 1-> IMAGINE THERE’S A PRIZE FOR CLOSEST TO 2/3 * AVERAGE CHOICE OF ROOM. PLEASE WRITE DOWN YOUR CHOICE. DISCUSS

ITERATION  ITERATIVE REASONING: EVIDENCE SUGGESTS THAT PEOPLE DO NOT WORK ACCORDING THE ITERATIVE REASONING. TWO TO FOUR ITERATIONS IS MORE LIKELY.  IN A SPECULATIVE BUBBLE THE THEORY OF THE BIGGER FOOL HOLDS.  BEAUTY CONTESTS – WHAT IS TRUTH HERE? THE OPINION OF OTHERS…

HERDING WHICH URN?  PLAYER 1: PICKS A RED BALL FROM SO DECIDES THAT URN A IS MORE LIKELY SIGNAL TO THE HERD: URN A MORE LIKELY  PLAYER 2: PICKS A BLACK BALL OUT  PRIVATE SIGNAL: URN B MORE LIKELY  HERD SIGNAL (FROM PLAYER 1): URN A MORE LIKELY  NOT SURE WHAT TO DO (50/50) BUT IMAGINE THAT PLAYER 2 DECIDES TO FOLLOW HERD AND CHOOSES URN A

INFORMATIONAL CASCADES  PLAYER 2: CHOOSES URN A  (FOLLOWING HERD SIGNAL)  PLAYER 3: PICKS A BLACK BALL SO HAS A PRIVATE SIGNAL THAT URN B’S MORE LIKELY THIS CONFLICTS WITH THE HERD SIGNAL: BOTH PLAYERS 1 & 2 HAVE PICKED A  PLAYER 3 IGNORES PRIVATE SIGNAL BECAUSE BOTH PREVIOUS PLAYERS HAVE PICKED A  SO ALSO PICKS URN A

HERDING  “INFORMATIONAL CASCADES” BUT THE HERD MIGHT CASCADE DOWN THE WRONG PATH!

LEARNING 3:  TRUTH IS A SLIPPERY CONCEPT WHEN THE ACTIONS OF OTHERS GOVERN WHAT WE BELIEVE

SECTION 2 ARE PEOPLE RATIONAL ANYWAY?

THE ULTIMATUM GAME  2 EXPERIMENTAL SUBJECTS: PROPOSER AND RESPONDER  PROPOSER GIVEN SOME MONEY, E.G. £100, WHICH THEY CAN DIVIDE AS THEY LIKE OFFERING RESPONDER ANY AMOUNT FROM £1 UP  RESPONDER CAN ACCEPT OR REJECT THE OFFER BUT IF RESPONDER REJECTS, NEITHER GETS ANYTHING

QUESTION 2:  IMAGINE YOU ARE THE PROPOSER IN THE ULTIMATUM GAME.  PLEASE WRITE DOWN WHAT SUM YOU WOULD LIKE TO OFFER ME AS RESPONDER.

DISCUSS

HEURISTICS  A RULE OF THUMB WORKS WELL WHEN IT IS CHEAPER THAN THINKING THROUGH ALL THE OPTIONS AND CALCULATING THE DECISION / GETTING EVIDENCE.

KAHNEMEN AND TVERSKY  GATHERED A LOT OF EVIDENCE FOR THE USE OF HEURISTICS IN DECISION MAKING (PROSPECT THEORY 1979). KAHNEMAN WAS GIVEN THE NOBEL MEMORIAL PRIZE FOR THIS IN FURTHER READING: THINKING, FAST AND SLOW

THE LINDA PROBLEM  LINDA IS 31 YEARS OLD, SINGLE, OUTSPOKEN AND VERY BRIGHT. SHE MAJORED IN PHILOSOPHY. AS A STUDENT, SHE WAS DEEPLY CONCERNED WITH ISSUES OF DISCRIMINATION AND SOCIAL JUSTICE, AND ALSO PARTICIPATED IN ANTI-NUCLEAR DEMONSTRATIONS. [THIS IS THE ORIGINAL FORMULATION FROM THEIR BOOK, IT IS A BIT POLITICALLY INCORRECT!]

QUESTION 3  Question 3: please circle the most likely alternative: 1. Linda is a bank teller. 2. Linda is a bank teller and is active in the feminist movement. DISCUSSION

CONJUNCTION FALLACY  AND AN EXAMPLE OF THE REPRESENTATIV ENESS HEURISTIC

QUESTION 4  IN ANOTHER EXPERIMENT, PARTICIPANTS WERE ASKED: CONSIDER A REGULAR SIX-SIDED DIE WITH FOUR GREEN FACES AND TWO RED FACES. THE DIE WILL BE ROLLED 20 TIMES AND THE SEQUENCE OF GREENS (G) AND REDS (R) WILL BE RECORDED. YOU ARE ASKED TO SELECT ONE SEQUENCE, FROM A SET OF THREE, AND YOU WILL WIN £50 IF THE SEQUENCE YOU CHOOSE APPEARS ON SUCCESSIVE ROLLS OF THE DIE.

PLEASE CHOOSE ONE 1.RGRRR 2.GRGRRR 3.GRRRRR

THE GAMBLER’S FALLACY  65% OF PARTICIPANTS CHOSE THE SECOND SEQUENCE, THOUGH OPTION 1 IS CONTAINED WITHIN IT AND IS SHORTER THAN THE OTHER OPTIONS  TVERSKY AND KAHNEMAN ARGUED THAT SEQUENCE 2 APPEARS "REPRESENTATIVE" OF A CHANCE SEQUENCE

LEARNING 4  HEURISTICS ARE SUBJECT TO SYSTEMATIC BIASES

TRY QUESTION FIVE

ANCHORING  WE BASE OUR GUESSES ON READY REFERENCE POINTS. SOMETIMES THIS IS ARBITRARY.

CONCLUSION AND DISCUSSION  THERE ARE LEVELS OF COMPLEXITY TO REACH THE TRUTH ABOUT HOW WE BEHAVE  THE ‘TRUTH’ IS NOT NECESSARILY RELEVANT TO THE RIGHT ANSWER  WE DO NOT ALWAYS DEAL WITH ‘TRUTHFUL’ INFORMATION RATIONALLY

5 MARCH 2015 TOK LECTURE TRUTH: TNML