3 Concepts to Better Decision Making - applied behavioral economics


Uploaded by Nanamizushima on 19.07.2012

Transcript:
Three concepts to better decision-making applied behavioral economics by Nana Mizushima
Three concepts to better decision-making applied behavioral economics by Nana Mizushima
Hi. I’m Nana Mizushima. Thanks for coming to watch this video tutorial on improving your decision making.
you can watch this video at your convenience
You can also choose to read the captions of my talk while you watch or
download a PDF of the slides
first let me tell you a little bit about myself. I'm a Colorado native
and went to the University of Colorado where I majored in economics.
then I went to New York City where I earned a master's degree from the school of international and public affairs at Columbia university
I've lived overseas for over 10 years in Europe and Asia
and that included several years with the Japan-US Educational Commission in Tokyo and a year in Indonesia so one of my interest is cross
cultural communication. I've also taught at Front Range Community College
Done Japanese English interpreting and I am a lifelong learner.
Why do we need to know how to make decisions? Well, whether we need to select a crate or a mate,
almost every decision we make is an economic decision
I am being a bit facetious but my point is that almost every decision people make whether it is
in the workplace or at the store or at home there are economic elements
people consider the cost, benefits then decide what to do. In my previous tutorial on
information we looked at how we collect information
in this tutorial I'm going to introduce three basic economic concepts to explain our decision-making process
and then I will show you three cases of how people have used these three concepts to improve the decision-making
where do these decision-making ideas come from?
here is a short list of authors and their books
Daniel Kahneman is a professor of psychology and received 2002 Nobel Prize in Economic Sciences for his work on decision-making.
Michael Lewis wrote interesting books on the global financial crisis
and the 2008 Wall Street meltdown,
Don Tapscott wrote on how crowdsourcing is being increasingly used,
Professor Richard Thaler explained his behavioral economics theories in Nudge,
the economist Stephen Levitt and the New York Times journalist Stephen J. Dubner wrote Super Freakonomics
to give examples of how people are motivated to make certain economic decisions.
I just recently read David Brooks’ book on how “success” happens through the use of a story about one composite American couple, Harold and Erica.
all these books are about economic decisions that people make
some of you may be familiar with Adam Smith who wrote the wealth of nations and the concept that the invisible hand
I'll read a quote here from his work

and he is in this as in many other cases led by an invisible hand
to promote an end which was no part of his intention nor does it always the worse for the society that it was not part of it
by pursuing his own interest you frequently promotes that of the society more effectively
than when he
actually intends to promote it
In other words, traditional economists assumed
that all consumers and producers not only have access to all information, but that that they're also smart and rational
so people always buy the best products at the best price. rational models were fashionable
through the 1980s. people were assumed to be self interested competitive
and calculating. free markets allow people to find the best price at the right quantity
naturally the most socially beneficial products and services would thrive, while those services - while those products and services which are bad for us
or community would die off
But are people really about way? We're humans not zombies.
Let’s look at just one example of how real humans make decisions
in the food industry. in the U.S. Food is a free market where consumers are free to choose from
a large variety of foods put out by many producers
we have a lot of information on food and our health. producers are highly sensitive to the wants of the
consumers and consumers are aware of new products
But we’ve all heard the current statistics.
obesity is common, serious and costly. more than 1/3 U.S. adults
35.7% are obese. in 2008 medical costs associated with obesity were estimated at $147,000,000,000
the medical costs paid by third party payers for people who are obese
were $1429 higher
than those of normal weight
they are similar cases of poor decision-making in other fields
health, money, relationships, work and the many other areas where we make daily decisions
it doesn't seem to matter how much information we already have
so does that mean Adam Smith is wrong? is our system broken? No, we need to understand
that the assumptions behind the decision-making are wrong not the system
so why do we make the decisions?
Adam Smith's idea of an invisible hand assumed that we're all rational decision makers
now behavioral economics has grown trying to explain our real decision making process
this presentation introduces three behavioral economic concepts to explain our decision-making process
and how we can improve it
I will use three metaphors
the coffee table, Mr. Spock and Captain Kirk
and trading mugs to show you three specific decision-making processes people often have problems with
then I will use the same concepts to show three practical real Life Solutions
to these problems
The coffee table problem
which of these two coffee tables fits into your living room best?
which did you choose?
well the answer is they are both exactly the same
you're going to doubt this answer but try measuring the table tops yourself with a pencil or a ruler
so if you measure the bottom of this first table here
it is the same as the end of the second table
and if you take the length of the first table it's also the same as the bottom of the second table
the facts of this problem do not match up with your perception of the problem so why does your brain insist that these two tables are different
when the facts show that the tabletops are the same?
there are three possible reasons why people make the wrong decision here
there is a difference in our brains between what we consciously know and what we subconsciously
know. Our visual information is probably tied more closely to our subconscious mind
just as our bodies tend to crave certain things, our mind craves certain
ideas. in terms of food we crave fats, sweets and rich foods
in prehistoric times we needed to select those foods whenever it was available
in terms of thinking we crave stories that make sense
again, what helped our ancestors survive - rather than dry facts and statistics
humans are a social animal
much of our decision-making is influenced by our social environment. in an experiment they fed a chicken so that it was full and stopped eating but
when another hungry chicken was introduced into the cage, the full chicken began eating again
without thinking, humans also mimic others around this
remember that a coffee tables?
if we just saw two rectangular shapes
we probably would not make the same mistake but the extra information of the legs throws us off
the social cues of the coffee table picture trigger us to respond in a certain way
OK here is the second concept. Mr. Spock and Captain Kirk
here's a quick test and I will give you just a few minutes to read it and solve all three of these problems.
Jot down your answers on a piece of paper
OK
All right, so here are the correct answers
5¢, 5 minutes
and 47 days
don't be surprised if you got them wrong. these questions were given to many people and most people answer them incorrectly
in that case you're more like Captain Kirk who uses intuition or fast thinking. But Mr. Spock
would have gotten all the correct answers. How does Spock solve these problems?
he is analytical and uses slow thinking and in fact all of you could have gotten the correct answers if you thought like Spock.
so if you go through these questions slowly it's easy to find the correct answers.
so the first problem. a mug and a pen costs $1.10 in total
the mug costs $1.00 more than the pen. how much does the pen cost?
The pen has to cost 5 cents in order for the mug, at $1.05, to cost $1 more.
OK, the second question. if it takes five people 5 minutes to make five sandwiches, how long would it take 100 people to make 100 sandwiches?
it doesn't matter how many people are making sandwiches. it will take the same amount of time. 5 minutes
OK, the third question
in a yard there's a patch of weeds. every day the patch doubles in size. if it takes 48 days for the
patch to cover the entire yard how long would it take for the patch to cover half of the yard?
well, If the patch doubles in size each day, then it must be the 47th day when half of the yard was covered.
so why do people think like Captain Kirk?
I use Kirk to represent our Intuitive Thinking System while Spock represents our Analytical Thinking System.
Why don’t we always think like Spock? Spock is good at problems like this.
But, what is the question is
Which should you buy - the pen or the mug? Then Spock would start considering – how many pens do I have? How many mugs do I have?
How often do I need a pen/mug? How much money do I have?
Would a pen be more valuable than a mug in one year? and so on and so on
Spock would end up in an endless cycle of questions and answers and take all day to analyze the problem.
But Captain Kirk would simply think, “I like that mug. I’ll get that.” he is much faster and uses less energy
So although our Spock thinking
would be more accurate, it is impractical for anything more complicated than mathematical problems
we use our intuitive
thinking system to break up the logjam of data when we must make a judgment or decision. we tend to use our intuitive thinking system
most of the time. It is faster and easier but also prone to certain errors
but as long as most of the time the intuitive system works, we use it
Kirk is action oriented more emotional and uses less energy
He will kick Spock out of the way unless he is forced to give way.
the intuitive thinking system uses shortcuts or what are technically called “heuristics and biases”.
Professor Kahneman describes 9 of them in his book – Thinking, Fast and Slow.
But today let me just explain one shortcut: the concept of Anchoring which affects many of our daily decisions.
anchoring. this concept refers to the fact that all of us are consciously and subconsciously biased by information we have immediately before making
a decision. even professionals who believe they can be objective suffer from this bias
Professor Kahneman describes one experiment with real estate agents using Home Price anchors.
real estate agents were given an opportunity to assess the value of a house that was actually on the market
they visited the house and studied a comprehensive booklet of information that included an asking price
half of the agents saw an asking price substantially higher
than the listed price of the house
the other half saw an asking price
that was substantially lower. each agent gave her opinion about a reasonable buying price for the
house and the lowest price in which she would agree to sell the house
if she owned it. The agents were then asked about the factors that had affected their judgment. remarkably, the asking price was not one of these
factors. the agents took pride in their ability to ignore it. they insisted that the asking price had no affect on their responses
But they were wrong
41% of their opinions were biased
by the asking price that they saw. indeed the professionals were almost as susceptible to
anchoring effects as business school students with no real estate experience
48% of their opinons were biased. the only difference between the two groups were that the
students conceded that they were influenced by the asking price, the anchor
while the professionals denied
that they were influenced
here is a subtle anchor which even surprised me
Professor Thaler in his book Nudge describes a subtle anchor which influenced mood. anchors can in the even influence how you think your life is
going. in one experiment college students were asked two questions: a) How happy are you?
B) How often are you dating?
the correlation was 0.11 in other words, only 0.11 of the respondents said that their dating
frequency had anything to do with how happy they were
that when the question order was reversed so that the dating question came first and the how happy are you?
question came second. (a) How often are you dating? B) How happy are you?
the correlation jumped to .62%.
When prompted by the dating question first, students used it as an anchor to answer
the happiness question. the two questions are exactly the same
but just changing the order dramatically changes the results
I hope you can see that even subtle anchors significantly influence answers in forms, surveys or interviews.
Our intuitive thinking system, Captain Kirk, uses shortcuts like anchors all the time,
and often without even being aware of it
The third decision making bias we tend to use I will call Trading Mugs.
the technical term for this is the endowment effect. in an experiment by Dr. Thaler half of the students in a room are given coffee mugs.
Mug owners are invited to sell their mugs and non-owners are invited to buy them
traditional economic theory predicts that about half of the mugs will be traded so that the students
who most want a mug will buy one from the students who don’t want a mug.
But the results showed that very few mugs were traded. Those with mugs demanded roughly
twice as much money to give up their mugs as others were willing to pay to get one
so the conclusion is once I have a mug I don't want to give it up but if I don't have one I don't feel an urgent need to buy one
the Same tendency shows up in other experiments. Prof. Thaler calls this
the endowment affect
in behavioral economics endowment effect, the endowment effect or divestiture aversion is the hypothesis that a person's willingness to accept
compensation for a good is greater than their willingness to pay for it once their property right to it has been established
The endowment effect was described as inconsistent with standard economic theory which asserts that a person's willingness to pay for
good should be equal to their willingness to accept compensation to be deprived of the good. a hypothesis
which underlies consumer theory and indifference curves
Here's some possible strategies for
the coffee table, Mr. Spock and Captain Kirk, and the trading mugs biases
choice architecture is a term coined by Professor Thaler to take
these biases into account. the various biases people have when making decisions
so I'm going to give you some real life examples rather than theoretical or academic solutions.
using the coffee table concept to lose weight
Acknowledge our brain’s biases that our senses can fool us to not believe the facts.
Offer solutions which complement our cravings,
and make sure that the solutions fit our social nature
a friend of mine actually use the strategy successfully. her husband and two kids were having trouble with weight gain so she adopted
three strategies. Eat together at the home, use smaller dishes
and tell her family that they can eat as much as they would like but that they have to ask for seconds
the entire family was successful in losing weight this way
Use Spock and Kirk concept to fight litter problem.
remember Spock of the analytical thinking system?
he knows of that there's a serious litter problem in our highways because of all the information we have. But Kirk does not pay attention to the facts
well Texas officials were enormously frustrated by the failure of their well funded and highly publicized advertising campaigns
which attempted to convince people
that it was their civic duty to stop littering
many of the letters for men between the ages of 18 and 24. an audience least likely to respond to a logical argument so they decide to appeal to
the intuitive Kirk instead of the analytical Spock.
the phrase don't mess with Texas was prominently shown on road signs on major
highways, television, radio and print advertisements
rather than force more information on the public, this short phrase appealed to the intuitive thinkers. the campaign is credited with reducing litter on
litter on Texas highways roughly 72% between 1986 and 1990
The campaign's target market was 18-35 year old males, which was statistically shown to be the most likely to litter.
beyond its immediate role in reducing litter, the slogan became a Texas culture phenomenon
and the slogan but has been popularly appropriated by Texans
the phrase Don't Mess With Texas is a frequently cited example of pride in Texas culture
now, the trading mug concept in the workplace. remember the coffee cup experiment?
“Once I have a mug, I don’t want to give it up. But if I don’t have one, I don’t feel an urgent need to buy one.”
also called the “endowment effect”. How can we use this concept in the workplace?
Can individual and office productivity improve by using this concept?
In a 2010 paper Tanjim Hossain of the University of Toronto and John List of the University of Chicago worked with the managers of a
Chinese Electronics Factory who are interested in exploring ways to make their employee bonus scheme more effective
at the beginning of the week some groups of workers were told that they would receive a bonus
of 80 yuan, about $12.00 at the end of the week week if they met a given production target.
other groups are told that they had provisionally been awarded the same bonus $12 also due at the end of the week but that they would
lose it if their productivity fell short of the same threshold
Objectively these are two ways of describing the same scheme. But under a theory of loss aversion, the second way of presenting the bonus should work better.
should work better. and workers would think of the provisional bonuses as theirs, and work harder to prevent it from being taken away
this is just what the economists found
the fear of loss was a better motivater than the prospect of gain which worked too but less well. and the difference persisted over time. the results
were not simply because of a consequence of workers misunderstanding of the system
this research suggests
that choice architecture or
How a choice of presented may be as important as the choice itself
use behavioral economics to improve your life. remember Adam Smith wrote his classic
economics work with the concept of an invisible hand in a free market economy
back in 1776, the same year as the birth of our nation. It was very influential work in
establishing our belief in the free market system
and individual choice. As Americans, we still firmly believe that the individual's right to life, liberty and the pursuit of happiness happiness
will lead to a better and more prosperous society
but Adam Smith's invisible hand doesn't always pick the best choice
We need a steering wheel, so to speak, to equip ourselves with conceptual tools to make good decisions
I hope that these three metaphors and examples clarify the behavioral economic concepts you can use to improve the decision-making process
The Coffee Table showed how all humans have built in biases and tendencies which need to be accommodated rather than ignored.
In the Mr. Spock and Captain Kirk exercise, Spock represents our Reflective, Analytical Thinking system which is usually correct but slow.
Captain Kirk is our more often used Intuitive Thinking system,
a fast system which relies on shortcuts such as Anchoring
that can lead to biased decisions
Trading Mug reminds us that people tend to overvalue what they have, and undervalue what they do not have.
choice architecture refers to a conscious effort to present choices in such a way as to
accommodate are intuitive thinking system and our human biases.
Use the information from this presentation the next time you want to make GOOD decisions
to improve your life and community
for more information on this topic and other topics please contact me
Thanks for watching.