1. Anchoring, availability and representativeness
Lecture 5

2. Tversky & Kahneman: Judgment under Uncertainty: Heuristics and Biases
Summary in three slides

3. Representativeness heuristic
Usually employed when people are asked to judge the probability that an object belongs to a certain class
Probabilities are evaluated by the degree to which A is representative of B (resembles B).
When A is highly representative of B,
the probability that A originates from B is judged to be high.
On the other hand, if A is not similar to B,
the probability that A originates from B is judged to be low.

4. Availability heuristic
Biases due to the retrievability
Lists of men and women (in some more famous women; in some more famous men) ... easier to recall names of famous people
Biases due to the effectiveness of a search mechanism
Word starts with an r or its third letter is an r
Biases of imaginability
Committees of size 2 and 8
Illusory correlation
Associative connections are strengthened when the events frequently co-occur

5. Anchoring Anchoring can happen with completely trivial anchors
Social security number influenced the subjects’ estimate of the number of doctors on Manhattan
Throwing dice influenced the judges’ estimate of the proper prison sentence length in a given case
Anchoring is more effective the less we know about the target
But are real-life anchors this uninformative?
Wages
Buying prices
Internet helps us find more correct reference prices

6. Hammond, Keeney, Raiffa: The Hidden Traps in Decision Making

7. Key idea Lists biases relevant to business decisions Anchoring
Status quo bias
Sunk cost fallacy
Confirmation bias
Framing
Biases in forecasting

8. Anchoring How do you estimate the sales of a product?
Often too much anchoring on past sales
Anchors in negotiations
Salaries, sales prices, contract terms
Setting the anchor is a powerful tool
What can you do?
Use different opinions, perspectives, and analysts
Don’t let them anchor on your initial idea

9. Status quo bias Sin of omission is not seen as bad What can you do?
Killing someone vs. failing to save
”If it isn’t broken, don’t fix it”
What can you do?
Think, would you really choose this from a choice set?
Jump into the future after ”rocking the boat” – which alternative is better?
On the other hand, sometimes status quo is indeed the smart choice
“If I had asked people what they wanted, they would have said faster horses.” –Henry Ford

10. Sunk cost fallacy
Suppose you invest 1 million in developing a new product, but the prototype is a failure. What should you do now?
Give up, and abandon the product
Invest more to make it a success
What can you do?
Solicit opinions from someone who is not involved in the history (no stake)
Own up to failures, and make it a good thing in the culture
Look at quality of decision making process, not just outcomes
Is the narrative of headstrong perseverance always right?

11. Confirmation bias
We interpret ambigous evidence favorably to our opinion
Wason’s 2,4,6 example
More data may just mean ”more reasons I’m right”
What can you do?
Have someone play devil’s advocate (maybe anonymously, depending on culture)
Think of your goals: are you hunting for truth or arguments?
Avoid people who always agree with you

12. Framing
When things are framed in losses vs. gains, decisions change (examples in Lecture 6)
Different reference points can result in different frames
What can you do?
Consider different frames – what are you expecting?
What is a ”good result” in your problem, and why?
Write out all the results of a choice, don’t leave them implicit

13. Biases in forecasting We are widely overconfident of our forecasts
On the other hand, we pad forecasts ”just to be safe”
Our supporting data is biased by what we remember
What can you do?
List reasons why you might be wrong, and revise your estimate
Have a culture of honesty about estimates
Keep a database to estimate accuracy
Use actual unbiased data whenever possible

14. The Systems of Thinking
Mostly from:
Kahneman: Maps of Bounded Rationality: Psychology for Behavioral Economics, The American Economic Review, Vol. 93, No. 5 (Dec., 2003), pp

15. Heuristics and biases Biases Heuristics ”Rule of thumb”
Mental shortcut
Quick and dirty solution
Instead of exhaustive search
Linked often to intuition
Not always bad! (Lecture 7)
Eg. Chess masters
Pattern of deviation in judgment
Compared to some objective standard
Statistically systematic
Not predictable on individual level
Clearly visible in larger samples
Hot (emotional)
Cold (cognitive)

16. Why do heuristics & biases matter?
Concern about reliance on judgmental heuristics
not attributable to motivational effects
These heuristics are highly economical and often effective, but
they sometimes lead to systematic and predictable errors
Experienced researchers (when they think intuitively) are prone to many of the same biases as laymen
Learn from lifelong experience
Is it sufficient to be internally consistent in probability statements?
What can we do about the biases?

17. Dealing with biases
Kahneman is not very hopeful about people being able to correct their own biases:
“I have been studying this for years and my intuitions are no better than they were.”
But correcting others looks more promising:
“But I'm fairly good at recognizing situations in which I, or somebody else, is likely to make a mistake - though I'm better when I think about other people than when I think about myself.
My suggestion is that organizations are more likely than individuals to find this kind of thinking useful.”

18. Conscious Effortful Deliberate WITH self-awareness WITH control
System 1
System 2
Can control
Unconscious Effortless Automatic WITHOUT self-awareness WITHOUT control
Conscious Effortful Deliberate WITH self-awareness WITH control

19.
Dual process theory
Intuition (System 1) thoughts seem to come spontaneously to mind, without conscious search or computation, and without effort
2 + 2 =
Driving a car in a “easy situation”
Reasoning (System 2) is done deliberately and effortfully
38 x 252 =
Turning left with car
Most individual’s thoughts and actions are normally intuitive
What about business decisions or decisions in organizations?

22. Consciousness Unconscious behavior Unconscious processing
Automatic with lack of awareness, intention and control
Inaccessible to conscious mind
Unconscious processing
Our perceptions, memory, and social judgments are all constructed by our unconscious mind
Limited data, employing context, expectations and even desires
Nature has created to make us survive
System 1 product of thousands of years of evolution

23. Perception and System 1
Our social perception is not a direct result of what we experience,
But constructed by our minds, employing context, prior knowledge, and desire
Visual perception
The ease with which mental contents come to mind
Reference dependence
Mind fills in the missing parts of the information

24. Reference dependence

25. Our mind fills in the missing information

26. Our mind fills in the missing information
A girl learned to read
at age of 4.
What is her likely level
of education?
Social factors (no siblings)
Environmental factors (learnt in an orphanage)

27. System 2 Lazy by nature Limited capacity Reasoning may be motivated
Avoid difficult decisions (organ donations)
Information overload (jam tasting and purchases)
Limited capacity
The Magic Number Seven
Reasoning may be motivated
Looks at conclusion that you want and limits information search on information that support the desired conclusion

29. Cognitive systems Source: Kahneman 2003 Perception
Intuition – system 1
Reasoning – System 2
Process
Fast, parallel, automatic, effortless, associative, slow-learning, emotional
Slow, serial, controlled, effortful, rule-governed, flexible, neutral
Content
Percepts, current stimulation, stimulus-bound
Conceptual representations;
Past, present, and future;
Can be evoked by language
Source: Kahneman 2003

30. The boundaries of thinking
The judgments that people express, the actions they take and the mistakes they commit depend on
The monitoring and corrective function of System 2
The impressions and tendencies generated by System 1
System 1 has been associated with poor performance, but it can also be powerful and accurate
System 2 monitors judgments lightly, on some occasions it may however detect potential error and an effort will be made to correct it

31. Stanovich (2009). What Intelligence Tests Miss: The Psychology of Rational Thought.

32. How can we improve thinking?
Thinking is impaired with:
Time pressure
Concurrent involvement in a different cognitive task
Thinking is influenced by:
Emotions
Mood
Context
Reasoning is positively correlated with:
Intelligence
Need for cognition (whether the individual enjoys thinking)
Exposure to statistical thinking