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Every Day Economics: About rationality in decision making. |
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Written by Simone Mariconda
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Friday, 13 March 2009 14:54 |
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Frequently when we make decisions we think we are under control. We are quite sure about ourselves, and we are confident about the process that guides our decision making. Classic economic consumer theory ta ught us that we are rational. We learned that when we are confronted with a problem we have a perfect knowledge of all alternatives, we also know the consequences of following a determinate course of action, we have a stable a consistent preference ordering and eventually we choose the outcome with the highest expected value! So damn easy! It has been a long evolutionary process, but at the end (hooray!) we have managed to become fully rational! Alas, at a certain point in history someone asked himself the question: “Are we really that perfect?”. In fact there was something incredibly simplistic about the assumption, economists used to make, that we are such perfect information-processing machines. Nobel prize winner (in 1978) Herbert Simon coined the expression bounded rationality to explain the fact that human beings have limited cognitive abilities and thus they can’t store all the information and process it without actually following some kind of mental shortcut. We have limits! We make mistakes on a daily basis.From that point on several scholars concentrated their efforts in trying to better understand what is not working when we use our brain to make decisions. In fact it can happen that we make a bad decision (or a simply satisfying one) because of, let’s say, environmental factors: we may be under time pressure, the information we have is confused or simply too much (information overload). Other times, though, the main problem is that our mind is playing tricks to us. Sometimes our brain is simply fooling us! Take for example the results of this experiment conducted by MIT professor Dan Ariely. An audience is asked to write down on a piece of paper the last two digits of their social security number (if it was done in Switzerland they could have asked for the last two digits of the AVS/AHV card). Then After writing down that two digits number, people are asked to guess the price of some items showed to them by the experimenters (e.g.: chocolate, bottles of wine). Guess what happened? People with higher two digits were submitting bids that were much higher on average than the others with lower two digits. It looked like the two digits were influencing the subsequent bid even if they were completely disconnected! Professor Ariely explains it as follows: “People don't know how much something is worth to them. An anchor helps them decide.” In fact people use the two digits as an anchor and then adjust their evaluation according to their perception. This bias is famous in fact as anchoring trap or anchoring and adjustment trap (discovered by Amos Tversky and Daniel Kahneman). According to numerous experiments it was showed that individuals anchor, or over rely, on specific information (derived from past experience) and then adjust to that value to account for other elements of the circumstance. Usually once the anchor is set, there is a bias toward that value. Consider this other experiment to better understand the dynamic of anchoring. A group of people were asked the following two questions: Is the population of Turkey greater than 35 million? What is your best estimate of the population of Turkey?Then another group was asked the same two questions, but instead using 100 million (previously 35 million) as a starting number. Again guess what? If you’ve read carefully at this point you should be able to imagine what happened. Got it right? Exactly! People that were asked the question with the 100 million figure were giving higher estimates! The number used to ask the first question worked as an anchor and influenced the answer to the second question. Frequently when making decision, without noticing, we rely on anchors. It could be that we rely too heavily on past sales when working on budgeting for next year, it could be that we give disproportionate weight to a comment made by a colleague, or accept the initial offering made by a real estate agent when we are negotiating the price for our new house without trying to actually make an objective evaluation, and so on and so forth. What is astonishing is that we tend to anchor on a given piece of information even if it has not any relation with the question we are asked to answer. There are several other examples of cognitive biases that are fooling ourselves on a daily basis. These mistakes are somewhat recurrent and predictable. That’s why scholars are studying them. In order to try to help us to understand the way our mind sometimes deceives us and train us to avoid it before it happens. If you are interested in reading more about the topic simply type “cognitive bias” in Wikipedia or give a look at the book Predictably irrational written by Dan Ariely. The book has been translated in many languages and is easy and fun to read. I strongly recommend it to anyone interested in understanding something about decision making processes. Simone Mariconda Università della Svizzera italiana (USI).
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