Behavioral Economics Essay
Description
Assignment question:
Although most politicians have not studied behavioral economics in school, many of the best ones seem to have an instinctive understanding of it. Please discuss.
Feel free to talk about either an actual politician (living or dead) or a hypothetical, generalized one.
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Economics E-1035
Behavioral Economics and Decision Making
Game Theory
October 21, 2021
© Wilson Alan LLC | +1.978.402.8844 | Jon.Fay@WilsonAlan.com
Procrastination
100%
80%
60%
40%
20%
0%
© DSMcIntosh LLC
10/16
10/17
10/18
10/19
10/20
Page
1
Session 7: Temporal Bias
Different attitudes about time …
… lead to inconsistencies and biases
Exponential Discounting
U =
?
t
Preference Reversal /
Dynamic Inconsistency
ut / (1 + r)t
Hyperbolic Discounting
U =
? u / (1 + k t )
t
t
Sunk Cost Fallacy
Endowment Effect
Quasi-Hyperbolic Discounting
U = u0 +
? ? u / (1 +
t
t
© DSMcIntosh LLC
?)t
Status Quo Bias
Magnitude Effect
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2
Behavioral effects related to decisions with temporality
Commitment Strategy
An adaptation strategy that involves removing many
or even nearly all options except the one which is
preferred today
Dynamic Inconsistency
A type of preference reversal, which results from a
change in the time frame employed
Endowment Effect
Ascribing higher value to something that one already
owns than what one would otherwise pay to acquire it
Hyperbolic Discounting
A form of discounting where the denominator of the
discount factor increases linearly and not exponentially
Preference Reversal
A reordering in ones preference among available
choices, based on how the choices are framed
Quasi-Hyperbolic Discounting
A form of discounting that steeply discounts all future
events by applying both a constant ? and the typical
exponential discount factor to everything after to
Status Quo Bias
A preference for staying with the default option or the
current state
Sunk Cost
Expenditures of any sort that took place in the past
and will not be changed by any options being
considered in the present, but may still affect the
decision behaviorally
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3
Behavioral Effects
Complexity
Uncertainty
Temporality
Anchoring: Being
unconsciously influenced by
initial exposure to a number
that serves as a reference
point and influences
subsequent judgments
about value
Bounded Rationality:
Decision making that is
limited by the available
information, time, and
computational ability
Allais Paradox: When presented with two sets of choices which are
mathematically the same, people make conflicting choices because of the
possibility/certainty effect
Availability Bias: Overestimating the likelihood or impact of events based on
how easy it is to think of examples
Certainty Effect: The disproportionate change in utility of going from 95%
probability to 100%, as compared to 50% to 55%
Conjunction Fallacy: Belief that two possibilities taken together are more likely
than either one individually
Fourfold Pattern: The inconsistent behavior of being risk-seeking when facing
likely losses or possible gains, and risk averse when facing likely gains or
possible losses
Commitment Strategy: An
adaptation strategy that involves
removing many or even nearly all
options except the one which is
preferred today
Dynamic Inconsistency: A type of
preference reversal, which results
from a change in the time frame
employed
Endowment Effect: Ascribing higher
value to something that one already
owns than what one would otherwise
pay to acquire it
Framing: Positioning the
utility of an outcome as a
potential gain or potential
loss, in comparison to a
subjective base case
Heuristics: Mental
shortcuts, often
unconscious ones, that lead
to quicker decision making
Mental Accounts: Making
spending and investment
decisions within categories,
rather than comparing the
marginal impact of every
choice
Paradox of Choice: The
observation that people,
when given a greater
number of options, will fail
to make any choice
System 1 and System 2:
The two approaches that
our brains work in:
instinctively and analytically
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Gain/Loss Symmetry: The property arising when the way outcomes are
evaluated shows gains and losses of equal amounts having equal (absolute)
impacts
Loss Aversion: Choice behavior that implies that the psychological cost of
losing is perhaps twice as powerful as the pleasure of gaining
Natural Frequencies: An approach to calculating conditional probability by
counting how many members of a given population fall into each possible
outcome
Possibility Effect: The disproportionate change in utility of going from 0%
probability to 5%, as compared to 50% to 55%
Prospect Theory: A behavioral model of choice that incorporates how people
unconsciously deal with risk and with gains and losses
Representative Heuristic: A judgmental shortcut that places too much weight
on the sample’s similarity to something that is already familiar, ignoring base
rate probabilities
Risk Aversion: The observation that a loss of a certain amount results in a
greater loss in utility than a gain of the same amount, due to decreasing
marginal utility of wealth
Salience: The vividness of a characteristic, leading to greater ease of recall
and sometimes to overestimating the incidence and probability of something
Sample Size Fallacy: The law of small numbers, that it is easier to draw
incorrect conclusions from small sets of data
Hyperbolic Discounting: A form of
discounting where the denominator
of the discount factor increases
linearly and not exponentially
Preference Reversal: A reordering in
ones preference among available
choices, based on how the choices
are framed
Quasi-Hyperbolic Discounting: A
form of discounting that steeply
discounts all future events by
applying both a constant and the
typical exponential discount factor to
everything after to
Status Quo Bias: A preference for
staying with the default option or the
current state
Sunk Cost: Expenditures of any sort
that took place in the past and will
not be changed by any options
being considered in the present, but
may still affect the decision
behaviorally
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4
Thinking about Others in the Neoclassical Model
Traditional neoclassical theory assumes atomistic consumers and firms, which means
everyone is a price taker in the face of a large, anonymous market. Others effectively
become a background constant.
Consumption / b
Demand
Budget Line is straight because we assume our
consumption is minuscule compared to the
overall market, and so it cannot affect prices
Budget Line
a
Production / K
Supply
Isocost Line is straight because we assume our
use of factors is too small to affect factor market
prices, including wages and interest rates
Isocost Line
L
Theory of Firm /
Competition
DD=AR=MR Line
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Average and Marginal Revenue lines are straight,
horizontal, and coincident because we assume
our quantity is too small to affect product market
prices
dP = 0
dQk
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5
Others in the neoclassical model
Markets
Games
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6
Non-Cooperative Games
The Prisoners Dilemma
10
If Suspect 1 and Suspect 2 both hang tough
and do not confess, they both receive a
sentence of 2 years on the minor charge
that can be proved without a confession.
2
NOT
1
Suspect 2
2
1
5
CONFESS
5
10
CONFESS
NOT
Suspect 1
If one rolls over and testifies on the other,
the one who confesses will receive a plea
bargain of 1 year and the DA will throw
the book at the other, resulting in a 10 year
conviction.
If both suspects confess, theyll both do
5 years for the major crime.
What is S1s dominant strategy?
What is S2s dominant strategy?
In what real-life situations do we
see this game structure?
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7
Prisoners Dilemma: Payoff Map
1 year
You Confess, I Dont
Neither Confesses
2 years
YOUR
Jail Time
We Both Confess
5 years
I Confess, You Dont
10 years
10 years
5 years
2 years 1 years
MY Jail Time
Confessing is a dominant strategy for each of us
Nash Equilibrium
Cooperation would bring the best total outcome
Pareto Optimal Outcome
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8
Repeated Non-Cooperative Game
NOT
10
Suppose the penalties are minor fines
in dollars, not jail terms in years.
2
1
2
Suspect 2
5
1
CONFESS
5
10
CONFESS
NOT
Suspect 1
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Suppose further that you and I are
from the same team/gang/fraternity
and are likely to find ourselves in this
situation again (and again, and again).
Now what should I do?
In a repeated game, a tit-for-tat
tactic can signal reciprocity and lead
to learned tacit cooperation
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9
From Confessions to Contributions
Suppose we each have $20. We can
both either keep our $20 or put it into
the pool.
CONTRIBUTE
10
30
35
Money put into the pool will receive a
50% dividend.
30
Person 2
DONT
CONTRIBUTE
20
35
20
DONT
CONTRIBUTE
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What is the dominant strategy?
10
CONTRIBUTE
Person 1
The pool money and dividend will be
paid out equally, regardless of
whether we contributed.
In what real-life situations do we
see this game structure?
In cases of public goods, the
incentive is to be a free rider
Page 10
Public Goods: Payoff Map
I Contribute, You Dont
$35
We Both Contribute
$30
Your
Payoff
$20
$15
Neither
Contributes
$15
$20
You Contribute, I Dont
$30
$35
My Payoff
Like the Prisoners Dilemma, economic thinking drives us to a non-Pareto-Optimal
Nash Equilibrium
How can we get to the Pareto Optimal point, even in a single-period game?
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What if we could negotiate?
I Contribute, You Dont
$35
We Both Contribute …
Then Divide the Surplus
$30
Your
Payoff
$20
$15
Neither
Contributes
$15
$20
You Contribute, I Dont
$30
$35
My Payoff
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What if we could negotiate?
Non-Cooperative,
Benefits in Your Favor
Cooperative Solution
(Both Better Off
a Pareto Move)
Your
Payoff
Non-Cooperative,
Balanced
Non-Cooperative,
Benefits in My Favor
My Payoff
A negotiated or political solution can make us both better off
a Pareto Optimal move
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Cooperative, Positive-Sum (Win-Win) Games
Non-Cooperative,
You get more
Your
Payoff
Cooperative Solution
(Both Better Off
a Pareto Move)
Generating
Value
Non-Cooperative,
Splitting the benefits
Non-Cooperative,
I get more
My Payoff
In real life, why is it so hard to get to the Both Better
Off (Pareto Optimal) point?
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The Challenge of Pareto Optimizing: Winning
Distributing
Value
Your
Payoff
BATNAYou
Generating
Value
ZOPA
BATNAMe My Payoff
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Breakout: The Offer Game
Person A
I get:
$
The other person gets:
$
$
Person A moves first
10.00
(Offer must be a whole number)
Person B
I accept the offer
Then Person B responds
I reject the offer
(Choose only one)
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Breakout: The Offer Game
Person A
I get:
$
The other person gets:
$
$
10.00
If Person A is an Econ
neoclassical economist,
what will she offer if
she believes Person B
is also an Econ?
(Offer must be a whole number)
Person B
I accept the offer
I reject the offer
(Choose only one)
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If Person B is an Econ,
what is the lowest offer
he will accept?
If Person B is NOT an
Econ, what is the lowest
offer he will accept?
Page 17
Thinking about pie
Option (a)
Option (b)
You get $10
You get $0
and
The other person
gets $90
and
The other person
gets $0
Pick (a) or (b)
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First-mover game equilibrium
$10
Stackelberg Equilibrium,
Roles Reversed ($1, $9)
Stackelberg = 1st Mover Advantage
(aka Schelling Commitment Strategies)
Responders
Payoff
Stackelberg Equilibrium ($9, $1)
Proposers Payoff
$10
In real life, what can happen when you play a first-move commitment strategy?
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First-mover game theory meets social fairness
$10
Stackelberg Equilibrium,
Roles Reversed ($1, $9)
Responders
Payoff
Fair Solution for Zero-Sum
Game ($5, $5)
Typical
BATNA
Stackelberg Equilibrium ($9, $1)
Economists
BATNA
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Proposers Payoff
$10
Page 20
Fair or Not?
Demand is OK at ThunderPrint copy shop. In the past, the copy shop had to
compete with the local university to get employees, but the university has cut
back on staff hiring, so the copy shop cuts the hourly wage from $14 to $12
Fair
Not Fair
John Trent has run a general contracting business for the past five years. He has
been paying his assistant, Les, $14, which is the going wage for the job. Because
of the soft building market in New England, he has decided to get out of general
contracting and to get into painting. The going wage for painters assistants is
$12, so Mark notifies Les that he will be reducing Less pay to $12 an hour.
A major blizzard is forecast for tomorrow. The local hardware store raises the
prices of snow shovels by $5.
The Prius is in short supply because of a spike in gas prices. An auto dealer
charges a $1000 premium over sticker.
The Prius is in short supply because of a spike in gas prices. An auto dealer had
been offering a $1000 discount, but now drops the discount
A grocery store is well stocked with granulated sugar. The wholesale price of
sugar spikes due to a typhoon that destroys major cane fields. Future purchases
of sugar will be at the higher wholesale prices. The grocer immediately increases
the price of the sugar it has on its shelves.
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Norms in the Neoclassical Model
Traditional neoclassical economic theory doesnt have much to say about how we value others
Greed is Good: I dont care
about others
Im an Island: I dont care what
others might think about me
U 1( X 1, U i ( X i ) ) = U 1( X 1 )
Where U1(X1) is the utility #1 receives from consuming goods & services bundle X1, and Ui is the utility of anyone else
© DSMcIntosh LLC
Page 22
The Coin Jar Auction
Sealed Bid, English Auction
Distribution of Bids*
7
* Real data from a previous class
6
What do you think
Actual
was
the actual value?
Value
$8.00
5
4
Winning
Bid
$10.00
3
2
1
0
$0.01
$1.00
$1.01
$5.00
$5.01
$10.00
$10.01
$15.00
$15.01
$20.00
Good is unique,
and you are not a price taker
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Winners Curse and Bid Shading
If know that winning bid in past has typically been 25% high,
then shade your best guess by 20%
You need to think ahead and bid as though youve won
(another Bayesian probability problem)
25%
$0
© DSMcIntosh LLC
$8
Actual
Value
$10
Mean of Past
Winning Bids
Page 24
A Beautiful Number
A) Pick a number between 1 and 100.
B) We will calculate the average (arithmetic mean) of the numbers
selected by all students in class.
C) We will then calculate 2/3 of that average. Call this number W
(i.e., W = 2/3 * Class Average).
D) The student whose number from Step A is closest to W will win
the contest and receive a prize
What number would you pick, and why?
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A Beautiful Number
This game has a Nash equilibrium (what is it?)
But
does game theory work? (i.e., will you win by
playing a rational game theoretic strategy?)
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A Beautiful Number: Contingent, Iterative Thinking
Pick a number [0,100]
? µ cant be > 100
? 2/3 * 100 = 67
? So nobody will pick a # > 67
100
90
? So µ cant be > 67
80
70
? 2/3 * 67 = 44
60
50
? So nobody will pick a # > 44
40
30
? So µ cant be > 44
20
10
? 2/3 * 44 = 33
0
0 is the Nash Equilibrium
?
and so on
… a solution in which each player knows the strategies of the other
players, and no player can gain by changing strategy unilaterally
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A Beautiful Number: The Horror Version
Were going to auction off a $100 bill
The high bidder will pay me their bid and
receive the $100 bill
The second highest bidder will also pay me
their bid but will not receive the bill
Bidding will start at $0.01 for the $100
What do you think will happen?
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Endgame Games
Market Bubbles
https://myuniversitymoney.com/gold-and-market-bubbles/
Arms Races
https://en.wikipedia.org/wiki/Nuclear_arms_race
When do you get out? When do you de-escalate?
If you can see how it will end (badly), and if you cant stop playing,
a rational player wont start
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Its not rational to assume everyone is rational
Rational Strategies
Assume all other players
are sophisticated
Realistic Strategies
Take into account game structure:
gauge sophistication of other players
and assume some miscalculations
Naïve Strategies
Assume reaction functions
that are random or minimal
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By the Way, Not All Games Have Equilibria
Whats the winning strategy?
Winning strategy and equilibrium only exist if
you know youre little brother always plays Rock.
Non-transitive dice
Die #1: 1, 2, 5, 6, 7, 9
Die #2: 1, 3, 4, 5, 8, 9
Die #3: 2, 3, 4, 6, 7, 8
#2 beats #1 : 19/36
#3 beats #2 : 19/36
#1 beats #3 : 19/36
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Session 8: Game Theory
Larger # of of Players
Smaller # of Players
NonCooperative
Example
Prisoners
Dilemma
Cooperation
Game
Asymmetric
Bidding
Iterative
Ultimatum
Game
Coin Jar
p-Beauty,
Escalation
Iterative
100
90
80
70
60
50
40
30
20
10
0
Game
Theory
Outcome
Nash
Equilibrium
Public Goods
Problem
First-Mover
Advantage
Winners
Curse
Nash
Equilibrium
Behavioral
Outcome
Tit-for-tat
Tactics,
Learned Trust
Role of
Gov/Norms
Role of
Norms (e.g.,
Fairness)
Adjustment
Based on
Observation
Miscalculation Go to the
Party
But
Irrational
Leave Early
Expectations
© DSMcIntosh LLC
Negotiation/
Conflict Styles
Systematic
Divergence
Page 32
Interplay of neoclassical & behavioral economics
Whether non-economic human behaviors are biases to be solved or offer hope
for a better world depends on the details of the decision were looking at
Behavioral Biases
Psychology
(bounded, social, weak)
Behavioral
Model
Behavioral Tools
Bounded Rationality, Confirmation
Bias, Paradox of Choice, Loss
Aversion, Endowment Effect,
Conspicuous Consumption, etc.
Norms, Fairness, Trust, Altruism,
Reciprocity, Reasonable
Expectations, Clan Affiliation, etc.
are human problems to be
overcome to get to Pareto
.. are human ways to avoid being
trapped in the Nash Pit
Pareto Optimality
Unfortunate Equilibrium
(Economic Utopia)
Economics
(rational, selfish, willful)
(Economic Dystopia)
y
2
??
?
x
Large
© DSMcIntosh LLC
Number of Agents
1
Small
Page 33
Decision frameworks, tools and biases
Neoclassical
Economics
Managerial
Economics
Decision
Heuristics
Behavioral
Economics
Economic
ideal
Analytical
approximations
Rules of
thumb
Predictable
biases
Complexity
Optimization Waltz
Linear Programming
Uncertainty
Risk Aversion
Decision Tree
Temporality
Discount Rate
Community
Market Efficiency
Bounded Rationality
Commitment Strategy
Mental Accounts
Decision Strategy
Mathematical
Shortcuts
Expert Instincts
Paradox of Choice
Anchoring
Confirmation Bias
Survivorship Bias
Availability Bias
Goldilocks/Decoy Effects
Halo Effect
Estimation Heuristics
Decision Strategies
Breakeven
Overage/Underage
Fast-and Frugal Trees
Bayesian Probability
Loss Aversion
Probability/Certainty
Fourfold Pattern
Allais Paradox
Discounted Cash Flow
NPV
IRR as breakeven
Payback Period
Commitment Strategy
Negotiate w/ Future Self
Breaking Up Tasks
Present Bias
Sunk Cost Fallacy
Endowment Effect
Status Quo Bias
Dynamic Inconsistency
Procrastination
Game Theory
Tit-for-Tat
Norms, Fairness
Bright Lines
Reasonable Expectations
Collective Commitment
Bandwagon Effect
Positional Comparison
Conspicuous Consumption
Positional Arms Races
Group Identification
Peer pressure
Altruism
Nash Equilibrium
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Mid Term Paper
Although most politicians have not studied behavioral economics
in school, many of the best ones seem to have an instinctive
understanding of it. Please discuss.
Feel free to talk about either an actual politician (living or dead) or
a hypothetical, generalized one.
Format and logistics:
Due on Tuesday, October 26, at 8:00 pm EDT.
750 to 1000 words (approximately 3 to 4 pages)
Please submit in Word format (.docx)
Print setup in Letter Sized format (not A4)
Your name on the last page only
Please use adequately sized margins
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Economics E-1035
Behavioral Economics and Decision Making
Session 1: Common Biases
September 2, 2021
Using Zoom
Camera on during class
Do not use Zoom while driving. Ever.
Label yourself with your full name (rename with right-click)
Use a headset of some sort, depending on the room youre in
Microphone is muted by default
Raise your virtual hand to speak, then unmute when called on
Chat is not graded and doesnt count towards participation
Make sure youre running the most current version of Zoom
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Page 1
Warning: multitasking doesnt work
When trying to concentrate
on a task, an unread email in
your inbox can reduce your
effective IQ by 10 points.
Daniel J Levitan,
McGill University
When people think theyre multitasking, theyre actually just
switching from one task to another very rapidly. And every time
they do, theres a cognitive cost in doing so.
Earl Miller, MIT
https://www.theguardian.com/science/2015/jan/18/modern-world-bad-for-brain-daniel-j-levitin-organized-mind-information-overload
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Page 2
About me
AB in economics, Harvard College, magna cum laude
MBA, Harvard Business School
Management consultant, specializing in executive development
Teaching experience
HES: Behavioral Economics (2009, 2018present)
HES: Advanced Business Strategy (20162020)
Harvard DCE and Harvard Business Publishing (2018present)
Custom corporate strategy programs (19922016)
Professional experience in real estate investment banking,
management consulting, innovation, and facilitation
Author, The Art of Business (2005)
Best email: dsm216@g.harvard.edu
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Page 3
About you
Where will your primary location be during the term?
7 Countries, 16 US States
Burkina Faso
Canada
China
India
Scotland
UK
USA
N=35
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Prior students advice: Economics prerequisite
Understanding basic economics allows for a much more profound
processing of concepts shown in class.
Students should have a basic understanding of economics prior to
taking this course.
This isn’t a class that can be understood without understanding
economics initially.
Prior microeconomic concepts are useful.
A background in economics pays off.
Definitely only take after you’ve taken 10a and principles of
finance. I lost a few points on my grade because I simply didn’t
know certain things.
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You prior economics experience
What is something significant you learned in a prior microeconomics class?
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Economics and behavioral economics
Can we shed some light on questions like these?
People save less for retirement than they think they should
People are reluctant to sell a stock whose value has fallen
since they purchased it
People seem to be both risk-averse and risk-seeking at the
same time, buying both insurance and lottery tickets
People spend a windfall on different things than they do with
their regular income
People believe SUVs are safer than sedans
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Behavioral economics: A fusion of models
Neoclassical
Economics
Behavioral
Economics
Behavioral
Psychology
A Normative Model
A Blended Model
A Positive Model
If people make
decisions this way
A realistic model of how
people make different
types of decisions
How people
actually make
decisions
Then the economy will
allocate resources
efficiently
Rational
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Together with practical
suggestions for how to
make decision making
more rational
Realistic
Rationality
Realistic
Page 8
Paris, May 1952
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Page 9
Paris, May 1952
Please choose:
(a)
11% chance of getting $1 million
89% chance of getting nothing
(b)
10% chance of getting $5 million
90% chance of getting nothing
Zoom Poll
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Page 10
Paris, May 1952
Please choose:
(a) 100% chance of getting $1 million
(b)
89% chance of getting $1 million
10% chance of getting $5 million
1% chance of getting nothing
Zoom Poll
© DSMcIntosh LLC
Page 11
Lets run the numbers
(a) 11% chance of getting $1 million
89% chance of getting nothing
(a) 100% chance of getting $1 million
(b)
(b) 10% chance of getting $5 million
90% chance of getting nothing
89% chance of getting $1 million
10% chance of getting $5 million
1% chance of getting nothing
89% chance
of $1 million
11% chance
of $1 million
10% chance
of $5 million
100% chance
of $1 million
10% chance
of $5 million
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Page 12
Lets run the numbers
(a) 11% chance of getting $1 million
89% chance of getting nothing
(b) 10% chance of getting $5 million
90% chance of getting nothing
(a) 100% chance of getting $1 million
(b)
89% chance of getting $1 million
10% chance of getting $5 million
1% chance of getting nothing
$890,000
$110,000
© DSMcIntosh LLC
$500,000
$1,000,000
$1,390,000
$500,000
Page 13
Lets Run the Numbers
(a) 11% chance of getting $1 million
89% chance of getting nothing
(a) 100% chance of getting $1 million
(b)
(b) 10% chance of getting $5 million
90% chance of getting nothing
$11
0, 00
89% chance of getting $1 million
10% chance of getting $5 million
1% chance of getting nothing
$1, 0
0
$3
59
0
0, 00
00, 0
00
$$13,3
9900,0,
00000
0
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Page 14
Lets run the numbers
(a) 11% chance of getting $1 million
89% chance of getting nothing
(b) 10% chance of getting $5 million
90% chance of getting nothing
$39
0, 00
(a) 100% chance of getting $1 million
(b)
89% chance of getting $1 million
10% chance of getting $5 million
1% chance of getting nothing
0
$39
0, 00
0
What is going on
here?
Certainty
Effect
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Page 16
The decision maker in neoclassical economic theory
Homo Economicus
Rational:
Thinks through every
issue and always runs the
numbers
Selfish:
Looks out for himself, and
assumes others do, too
Willful:
Makes commitments to
himself that he always
keeps
Source: Prof. David Laibson, Harvard University
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Page 17
The decision maker in behavioral economics
Homer Economicus
Bounded:
Limited time and limited
horsepower for decisionmaking
Social:
Decisions are influenced by
their impact on others
Weak:
Cant be counted on to do
what he thought he would
Source: Prof. David Laibson, Harvard University
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Page 18
Decision makers vs. Decision modes
Caricature View
Decision Makers
System 1
(Thinking Fast)
Nobel Prize View
Decision Modes
System 2
(Thinking Slow)
Fast
Slow
Automatic
Conscious
Intuitive
Analytic
Associative
Logical
Not prone to doubt
Allows uncertainty
Effortless
Costly
Source: Based on Thinking, Fast and Slow, by Daniel Kahneman
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Page 19
Your mind plays tricks on you
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Page 20
Your mind plays tricks on you
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Page 21
Where do they cross?
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Page 22
This is your brain, leaping to conclusions
What Your Brain Does:
Predict what is coming next
Look for causal relationships
How Your Brain Does It:
Register smallest number
of data points possible
Draw conclusions and
inferences almost
instantaneously
What Results:
Lightning-fast data processing
Seeing the big picture
Occasional errors
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Page 23
Your mind employs predictable biases
Optical Illusions are about
Predictable Perceptual Biases
(what you see vs. reality)
Behavioral Economics is about
Predictable Decision Biases
(what you think vs. rationality)
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Page 24
Thinking about breakfast
6 Varieties
% Who Buy
24 Varieties
30%
How much do you think the % Who Buy increased when consumers
were given a choice of 24 varieties instead of just 6?
Zoom Poll
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Page 25
Thinking about breakfast
% Who Buy
6 Varieties
24 Varieties
30%
3%
Why?
Paradox
of Choice
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Page 26
Thinking about money
Decision 1
Decision 2
(a) $100 today
(a) $100 a year from now
or
or
(b) $110 in a month
from now
(b) $110 in a year and a
month from now
Pick (a) or (b)
Pick (a) or (b)
Zoom Poll
Zoom Poll
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Page 27
Thinking about money
Decision 1
Decision 2
(a) $100 today
(a) $100 a year from now
or
(b)
or
$110 in a month
from now
(b)
$110 in a year and a
month from now
What was going on here?
Dynamic Inconsistency
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Page 28
Thinking about Thailand
Populations (million)
Malaysia
North Korea
Taiwan
Cambodia
Laos
32
26
24
16
7
Do you think the
population of Thailand
is greater than or less
than the median
population of these
countries?
Zoom Poll
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Page 29
Thinking about Thailand
Populations (million)
Malaysia
North Korea
Taiwan
Cambodia
Laos
32
26
24
16
7
What do you estimate
the population of
Thailand is?
Private chat your
estimate to
David McIntosh
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Page 30
Thinking about Thailand
Populations (million)
Malaysia
North Korea
Taiwan
Cambodia
Laos
32
26
24
16
7
Thailand:
70 million
Anchoring
What was going on here?
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Page 31
Thinking about numbers
2-4-6-
What is the next number in this series?
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Page 32
Thinking about numbers
2 – 4 – 6 – 12
The natural tendency:
The better approach:
Does the theory fit the
data?
Are there other theories
that fit the data?
Are there ways to
disprove your theory?
Confirmation Bias
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Page 33
Thinking about anti-aircraft fire
Where do you think
most people
propose putting the
additional armor
plating?
Survivorship Bias
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Page 34
Thinking about sharks
If youre vacationing in the Bahamas, would it be rational to be afraid to
go swimming?
Irrationality Alert: Being
afraid to enjoy a swim in the
Caribbean, but not thinking
twice about taking a walk
around town is irrational
NUMBER OF SHARK ATTACKS
AND FATALITIES
Locality
Total
Fatal
USA
41
Australia
11
Bahama Islands
2
Canary Islands
1
Caribbean Islands
1
Cuba
1
French Polynesia
1
Guam
1
Israel
1
Mexico
1
New Caledonia
1
Republic of South Africa 1
Réunion Island
1
0
0
1
0
0
0
0
0
0
0
0
0
1
Worldwide
2
64
Anecdote trumps data
Recency trumps experience
Salience trumps probability
31
Number of pedestrians
killed during same year
Availability Bias
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Page 35
Thinking about disease
An outbreak of the deadly Shanti virus has infected everybody in a city of 60,000.
You have limited supplies of the powerful antidote, and must quickly choose
between two strategies:
Program A concentrates the response on a portion of the population
Program B spreads the response across the entire population
Program A
Program B
20,000 people will be saved,
guaranteed
1/3 chance 60,000 will be saved
2/3 chance all 60,000 will die
Which of the two options do you think people typically choose?
Zoom Poll
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Page 36
Thinking about disease
An outbreak of the deadly Shanti virus has infected everybody in a city of 60,000.
You have limited supplies of the powerful antidote, and must quickly choose
between two strategies:
Program A concentrates the response on a portion of the population
Program B spreads the response across the entire population
Program A
Program B
20,000 people will be saved,
guaranteed
1/3 chance 60,000 will be saved
2/3 chance all 60,000 will die
How can you re-word the two options in
such a way that people choose B over A?
© DSMcIntosh LLC
Page 37
Thinking about disease
An outbreak of the deadly Shanti virus has infected everybody in a city of 60,000.
You have limited supplies of the powerful antidote, and must quickly choose
between two strategies:
Program A concentrates the response on a portion of the population
Program B spreads the response across the entire population
Program A
Program B
20,000 people will be saved,
guaranteed
1/3 chance 60,000 will be saved
Program A
Program B
40,000 people will die,
for certain
1/3 chance all 60,000 will be saved
2/3 chance all 60,000 will die
2/3 chance 60,000 will die
Loss Aversion
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Page 38
Thinking about stocks
Lets say you bought two
different stocks a year ago
One has gone up in value, and
you have an unrealized gain on it
The other has going down in
value, and you have an unrealized
loss
Which stock would you be more
likely to sell?
Zoom Poll
Disposition Effect
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