1. Judgment & Decision Making
Lecture focuses on judgment and decision making
Seminal work by Kahneman & Tversky (K&T); see Kahneman (2011) Thinking Fast & Slow for more detail
Lecture will review tasks in which people try to behave rationally

2. Judgment & Decision Making
Kahneman & Tversky showed that people make systematic errors on certain tasks
That is people behave irrationally
Errors can be explained in terms of the psychological processes mediating these tasks

3. Judgment & Decision Making
Try this example.
Here is a personality sketch written by a psychologist based on tests of uncertain validity
Steve is very shy and withdrawn, invariably helpful but with little interest in people or in the world of reality. A meek and tidy soul, he has a need for order and structure, and a passion for detail.
Is Steve more likely to be a librarian or a farmer? Assume that Steve was selected at random

4. Judgment & Decision Making
Is Steve more likely to be a librarian or a farmer? Assume that Steve was selected a random
What is your answer?
Why?

5. Judgment & Decision Making
What is your answer?
Most people choose librarian as the correct answer
Why
Steve resembles the stereotypical librarian
But this ignores relevant statistical information
Many more farmers than librarians
Kahneman and Tversky (KT) proposed that participants made judgment on basis of a heuristic, representativeness

6. Judgment & Decision Making
Here is another example
You see a person reading the New York Review of Books on the TTC subway
Which is the better bet
She has a PhD
She does not have a college degree

7. Judgment & Decision Making
Heuristic
Rule of thumb is a heuristic
Resemblance or representativeness heuristic is not unreasonable, but it leads to predictable errors by participants
E.g., it ignores base rate information, that is, the fact that many more people are farmers than librarians
Base rate = relative frequency of different members of a group

8. Judgment & Decision Making
Heuristic
K&T argued that participants typically ignore base-rate information and make judgements on the basis of representativeness

9. Judgment & Decision Making
Kahneman model of judgment and decision making
Two modes or systems of thinking
System 1 – operates automatically and quickly with little or no effort and no sense of voluntary control
System 2 – allocates attention to effortful mental activities
Other terms for these two systems are for system1, automatic, and for system 2, controlled processing

10. Judgment & Decision Making
Model of decision making
Characteristics of system 1 (see Kahneman, 2011, page 105 for further details)
Generates impressions, feelings
Operates automatically and quickly with little effort
Creates a coherent pattern of activated ideas derived from our stored memories
Infers and invents causes and intentions
Focuses on existing evidence and ignores absent evidence

11. Judgment & Decision Making
Model of decision making
Characteristics of system 2 (see Kahneman, 2011)
Its operations are effortful and require attention
It is lazy, and does not invest more effort than strictly necessary
As a result the decisions that system 2 thinks it has chosen are often guided by system 1

12. Judgment & Decision Making
Accounting for error in Steve problem
System 1 generates ideas that produce a pattern of a ‘nerdy guy’
Fits with stereotype of a librarian
System 2
Endorses this idea and generates response
Note: system 2 did not critically evaluate the info not there, or critically evaluate its validity

13. Judgment & Decision Making
Anchoring effect heuristic
Here is an example of the anchoring effect
Anchor 1. Is the height of the tallest redwood more or less than 1,200 feet?
Anchor 2. Is the height of the tallest redwood more or less than 180 feet?
Anchor 1 mean estimate 844 feet
Anchor 2 mean estimate 282 feet

14. Judgment & Decision Making
Anchoring effect heuristic
Here is an example of the anchoring effect
Anchor 1. Is the height of the tallest redwood more or less than 1,200 feet?
Anchor 2. Is the height of the tallest redwood more or less than 180 feet?
Results
Anchor 1 mean estimate 844 feet
Anchor 2 mean estimate 282 feet

15. Judgment & Decision Making
Anchoring effect
Why is anchoring effect observed
Possibility 1
Participants believe the tree estimate provides useful information
Next study examined this possibility

16. Judgment & Decision Making
Anchoring effect
Wheel of fortune study
Wheel of fortune had numbers from 1-100, but was rigged; stopped only at 10 or 65
After seeing wheel of fortune stop (at 10 or 65), participants answered the following question
What is your best guess of the percentage of African nations in the UN?

17. Judgment & Decision Making
Anchoring effect
Wheel of fortune study
Results
When wheel of fortune stopped 10 ; participants guessed 25%
When wheel of fortune stopped 65 ; participants guessed 45%
Conclusion: participants are influenced by uninformative number; suggests system 1 may be operating
After seeing wheel of fortune stop (at 10 or 65), participants answered the following question
What is your best guess of the percentage of African nations in the UN?

18. Judgment & Decision Making
Anchoring effect
Anchor and adjustment
In some situations people appear to anchor then adjust
E.g., at what temperature does water boil at peak of Mount Everest
I know water boils at 100 degrees
I know water boils at lower temperatures at higher altitudes so I adjust my estimate downward
After seeing wheel of fortune stop (at 10 or 65), participants answered the following question
What is your best guess of the percentage of African nations in the UN?

19. Judgment & Decision Making
Anchoring effect
Anchor and adjustment
Anchoring and adjustment appears to require System 2 because adjustment requires attention
Evidence in support of this hypothesis
Participants adjust less when mental resources are depleted (memory loaded with digits) and when
Participants are slightly drunk
After seeing wheel of fortune stop (at 10 or 65), participants answered the following question
What is your best guess of the percentage of African nations in the UN?

20. Judgment & Decision Making
Anchoring effect
Anchoring may result from priming (System 1)
Evidence
Participants were asked about average price of German cars with either a high anchor or low anchor price
A high anchor primed luxury brands (Mercedes, audi), low anchor primed mass-market cars (Volkswagen)

21. Judgment & Decision Making
Anchoring effect
Anchor as priming
Argument
Primed concepts then act to bias estimated price of the average German car

22. Judgment & Decision Making
Anchoring effect
Conclusions. It appears that under certain circumstances anchoring results from
Priming via System 1
Adjustment via System 2

23. Judgment & Decision Making
Availability heuristic
Question.
What do people do when they wish to estimate the frequency of a category
E.g., what is the probability that people who enroll in York graduate from York U.?
What is the probability that you will be robbed in the next year?

24. Judgment & Decision Making
Availability heuristic
People assess frequency by judging how easily it is to bring to mind instances
Several factors can bias these estimates
1. ease of retrievability
2. salience of examples (e.g., observing a violent crime) may increase subjective probability estimates of crime frequency
3. media report crimes

25. Judgment & Decision Making
Linda experiment
Linda is 31 years old, single, outspoken, and very bright. As a student, she was deeply concerned with issues of discrimination and social justice, and also participated in antinuclear demonstrations.
Which alternative is more probable?
Linda is a bank teller
Linda is a bank teller and is active in the feminist movement?

26. Judgment & Decision Making
Linda experiment
Which alternative is more probable?
Linda is a bank teller
Linda is a bank teller and is active in the feminist movement?
How many select option 1. 2.

27. Judgment & Decision Making
Linda experiment
Which alternative is more probable?
Results from several studies
Linda is a bank teller – 15%
Linda is a bank teller and is active in the feminist movement? – 85%

28. Judgment & Decision Making
Linda experiment
Kahneman and Tversky labelled this the conjunction fallacy.
Logically, everyone should choose option 1 because option 1 includes everyone in option 2

29. Judgment & Decision Making
Linda experiment
Why do people make this error?
Hypothesized that Linda is representative of a stereotyped idea of a feminist (generated by System 1), and system 2 ignored logical fallacy being committed

30. Judgment & Decision Making
Prospect theory
Theory developed by Kahneman & Tversky
Attempts to understand decision making under conditions of risk
This problem has been investigated by several disciplines – statistics, economics, sociology, political science

31. Judgment & Decision Making
History
Bernoulli 1738 attempted to explain why people are averse to risk and why risk aversion decreases with increasing wealth
Bernoulli proposed that the psychological response to a change in wealth depends upon one’s initial wealth and decreases with increasing wealth. Psychological response to a change in wealth is called utility by economists

32. Diminishing utility of wealth, Bernoulli

33. Judgment & Decision Making
Bernoulli
as figure shows person with more wealth is less risk averse because loss of money results in less utility loss than person with less wealth

34. Judgment & Decision Making
Bernoulli
Are people risk averse
Try this problem
Which would you rather have $80 for sure or
80% chance to win $100 and 20% chance to win $10.
Most people choose the sure bet; i.e., they are risk averse

35. Judgment & Decision Making
Prospect theory
Most people choose sure alternative
Bernoulli proposed this is because the psychological value of money decreases as the amount of money increases

36. Judgment & Decision Making
Bernoulli
Prior to Bernoulli
Mathematicians at the time had proposed that the choice selected should be the alternative with the higher expected value; i.e., gambles were assessed by the weighted average of their outcomes, where each outcome was weighted by their probability

37. Judgment & Decision Making
Expected value of gambling alternatives are:
e.g., expected value of:
80% chance to win $100 and 20% chance to win $10 is $82 (.8 x x10)
Expected value of $80 for sure is $80 (1.0 x 80)
Therefore choose the riskier choice

38. Judgment & Decision Making
Bernoulli
Let’s look at Bernoulli again
The Table below shows the relation between wealth (in millions) and utility according to Bernoulli
Note: adding 1 million in wealth to a wealth of 1 million adds utility of 20, but adding 1 million of wealth to 9 million adds a utility of 4
wealth 1 2 3 4 5 6 7 8 9 10
utility 30 48 60 70 78 84 90 96
100

39. Judgment & Decision Making
Prospect theory
Bernoulli
According to Bernoulli you choose the option with the higher utility. Utility = weighted average of the utilities of the outcomes multiplied by the probabilities (note: utilities are derived from table)

40. Judgment & Decision Making
Bernoulli
Example: What would you rather have
Equal chances to have 1 million or 8 million Or
4 million with certainty
Utility = .5 probability x 10 (utility) + .5 probability x 90 utility
Utility = = 50
Or utility of 4 million = 60

41. Judgment & Decision Making
Prospect theory
Bernoulli
According to Bernoulli you choose the option with the higher utility. Utility = weighted average of the utilities of the outcomes multiplied by the probabilities (note: utilities are derived from table)
So you choose the certain option. That is, you are risk averse because of the diminishing subjective value of money (utility)

42. Judgment & Decision Making
Prospect theory
importance of Bernoulli
Bernoulli’s theory is one of the foundations of economics
It explains risk aversion in people
Bernoulli’s theory is normative (describes how you should behave)
Kahneman & Tversky argued that Bernoulli is wrong in several important respects and proposed prospect theory as a theory of human behavior

43. Judgment & Decision Making
Key assumptions of prospect theory
1. Evaluation of choice is relative to a neutral reference point. Outcomes that are better than the reference point are gains. Outcomes that are worse than reference point are losses. Note, unlike Bernoulli, prospect theory focuses on changes in wealth, not wealth
2. Diminishing sensitivity in the evaluation of wealth (just like Bernoulli)

44. Judgment & Decision Making
Prospect theory
Key assumptions of prospect theory
3. Loss aversion. When directly compared to each other, people hate losses more than they like gains

45. Subjective value of losses and gains, Prospect theory

46. Judgment & Decision Making
Prospect theory
this figure has psychological value of money on the y-axis and the dollar amount on the x-axis
note that there is a neutral reference point. To the right of the neutral point are gains; to the left are losses
note that the S-shaped curve reflects the diminishing sensitivity for gains and losses
note that the responses to losses of the S-shaped curve is stronger than the responses to gains. This is loss aversion

47. Judgment & Decision Making
Prospect theory
Try this problem
Assume you are richer by $300 than you are today. You are offered a choice between
A sure gain of $100 or
A 50% chance to gain $200 and a 50% chance to lose $0

48. Judgment & Decision Making
Prospect theory
Here are the choices by participants
Assume you are richer by $300 than you are today. You are offered a choice between
A sure gain of $100 or [72%]
A 50% chance to gain $200 and a 50% chance to lose $0 [28%]
Note: most people are risk averse with gains

49. Judgment & Decision Making
Prospect theory
Note: most people are risk averse with gains as shown in the previous figure.
According to prospect theory, the subjective value of a gain of $100 is more than the 50% of the value of a gain of a second $100

50. Judgment & Decision Making
Prospect theory
Try this problem
Assume you are richer by $500 than you are today. You are offered a choice between
A sure loss of $100 or
A 50% chance to lose $200 and a 50% chance to lose $0
Do you choose option A or option B

51. Judgment & Decision Making
Prospect theory
Here are the results from an experiment
Assume you are richer by $500 than you are today. You are offered a choice between
A sure loss of $100 or [36%]
A 50% chance to lose $200 and a 50% chance to lose $0 [64%]
Note: most people are risk seeking with losses; that is, they choose the riskier option

52. Judgment & Decision Making
Prospect theory
Note: most people are risk seeking with losses. To see why refer back to the figure. In the cases of losses the pain of losing the second hundred dollars is less than the pain of losing the first hundred, so people are ready to take the risk of losing more to have the chance to get back to no loss.

53. Judgment & Decision Making
Prospect theory
In general people are loss averse. That is, a loss hurts more than an equivalent gain. For many people the loss hurts about twice as much as a gain so most people want to avoid a loss.
Important implication of prospect theory. It is crucial in making a choice whether you are framing choice in terms of gains or losses
if it is a gain you are risk averse
if it is a loss you are risk seeking

54. Judgment & Decision Making
Prospect theory – importance of framing
Problem 1. Imagine that the U.S. is preparing for the outbreak of an unusual disease, which is expected to kill 600 people. Assume that the exact scientific estimates of the programs are as follows:
If Program A is adopted, 200 people will be saved
If Program B is adopted, there is a 1/3 probability that 600 people will be saved and a 2/3 probability that no people will be saved

55. Judgment & Decision Making
Do you prefer program A or program B

56. Judgment & Decision Making
Prospect theory
Here are the results
If Program A is adopted, 200 people will be saved [72%]
If Program B is adopted, there is a 1/3 probability that 600 people will be saved and a 2/3 probability that no people will be saved [28%]
Note: most people choose the risk averse option.

57. Judgment & Decision Making
Prospect theory – importance of framing
Note: most people choose the risk averse option.
Why.
The problem is ‘framed’ as follows: reference point is that 600 people will die and 2 possible options described as gains are presented. Since it is framed as a gain, prospect theory predicts that people will be risk averse

58. Judgment & Decision Making
Prospect theory
Problem 2.
Same cover story but with the following options
If Program C is adopted, 400 people will die
If Program D is adopted, there is a 1/3 probability that nobody will die and a 2/3 probability that 600 people will die.
Which program do you select C or D?

59. Judgment & Decision Making
Prospect theory
Problem 2.
Same cover story but with the following options If Program C is adopted, 400 people will die (22%)
If Program D is adopted, there is a 1/3 probability that nobody will die and a 2/3 probability that 600 people will die. (78%)
Note: people are risk seeking here No

60. Judgment & Decision Making
Prospect theory
Note: options A and B and C and D are logically indistinguishable.
However, for C and D the alternative are in terms of losses – people dying – not gains as for options A and B No

61. Judgment & Decision Making
Prospect theory
Because alternatives are framed as losses, prospect theory predicts that participants will select the risk seeking behavior
Conclusion. When dealing with gains, people tend to be risk averse. When dealing with losses, people tend to be risk seeking.
The wording of options has a strong effect on choices people make
Called the framing effect No

62. Judgment & Decision Making
Intertemporal choice
refers to a situation in which a person must choose between a smaller immediate reward and a larger reward later. No

63. Judgment & Decision Making
Intertemporal choice
Marshmellow experiment classic intertemporal experiment
Walter Mischel carried out a series of experiments with 4 and 5 year old children. Each child was shown into a private room and seated at a table. In front of the child was marshmellow. Child was told that experimenter was leaving for a while and if the marshmellow was not eaten the child would get a second marshmellow. No

64. Judgment & Decision Making
Intertemporal choice
Marshmellow experiment classic intertemporal experiment
Results. Many children could not control themselves and ate the marshmellow.
Interpretation. According to the discounting perspective, the subjective value of the reward is discounted from its nominal amount as the delay increases No

65. Judgment & Decision Making
Intertemporal choice
Procedure for studying temporal discounting.
Participants choose between a smaller immediate reward and a larger delayed reward. Participants makes a series of choices in which the amount of amount of the immediate reward is varied at a given delay. Using this procedure you can determine the subjective value of the delayed reward at a given delay. (Green & Myerson, 2004) No

66. Temporal discounting procedure (from Green & Myerson, 2004)
People make a series of choices between a smaller amount now and a larger amount in 6 months
Goal to determine the immediate dollar value that receiving $1000 is equal to.
By doing this for a series of different time delays (e.g., 1 week, 1 month, 6 mos, 1 year, 10 years it is possible to obtain a discounting curve

67. Subjective value of $1000 at different delays (Green & Myerson, 2004)
Notes
The subjective value of $1000 at a short delay is almost $1000 but drops to less than $400 after 6 months.
All participants show temporal discounting. Older adults show less steep temporal discounting