.. Flashcards
what is a decision
‘a commitment to a course of action that is intended to produce a satisfying state of affairs’ (Yates, Veinott & Patalano, 2003).
It:
Involves a choice between actions (which may include inaction)
Is goal-oriented
Usually involves evaluation of outcomes
But, there are different types of decisions
strategic decisions
Strategic decisions: involve the general direction taken by an individual or organization, some time to make and involve outcomes that occur in the long-term.
tactical decisions
Tactical decisions: involve the implementation of strategy, stream of smaller scale decisions, take shorter time to make, outcomes that occur in the shorter term.
operational decisions
Operational decisions: day to day decisions making needed to execute plans and tactics.
unstructured decisions
Unstructured decisions: general understanding for the need to act, but no clear idea about goals/objectives, the alternative actions that are available or how they should be evaluated.
structured decisions
Structured decisions: clear objectives, a clearly defined choice set and an understanding of how the alternatives are to be evaluated.
risky decisions
Don’t know which of several outcomes may occur (e.g. Investment depends on whether upturn or downturn in the economy)
• Involves risk and uncertainty
riskless decisions
- Outcomes known (know what we get if we choose something). Problem is knowing which is the best value option
- Need to trade-off cost and value
normative theories
Normative theories prescribe what people should do if they wish to be rational decision makers.
These theories determine that to be rational people must maximise utility in the way prescribed in economics.
The theories are formal, based on sets of axioms or assumptions.
All the assumptions are deceptively simple and reasonable and there is an underlying mathematical proof which shows that for any person accepting the assumptions (and most people do when they are presented with them), it is possible to identify the rational or best course of action for that individual in that situation.
This normally involves maximising the best interests of the decision makers or maximising expected utility.
descriptive theories
Descriptive theories are concerned with explaining what people actually do and how they do it, rather than what they ought to do.
Descriptive theories may be developed in terms of mathematical models describing how the decision information is combined to determine choice or they may be developed in behavioural terms identifying the psychological/thinking processes involved in determining choice.
prescriptive theories
Prescriptive theories take account of what we know about the difficulties people have in making decisions and use this to prescribe procedures that people should follow if they wish to make a good decision.
In the early days this involved procedures that ensured people were consistent with the normative theory (i.e. maximise their utility). This focus has changed in recent years and moving from System 1 to System 2 thinking has become the focus.
decision theory - as an example of normative theory
von Neumann & Morgenstern (1947) developed a way of formally quantifying decisions
• based on a number of axioms (rules)
• covers both riskless and risky decision situations (we will focus on risky decisions)
example of decision theory
A = y axis S = x axis
A1...An = choice alternatives S1...Sn = possible states of the world O11...Onn = all possible outcomes
Value (utility) of outcomes to the decision maker which are subjective, are put in all the possible outcome boxes.
Probabilities of states of the world (based on intelligence)
to determine the best alternative, need to calculate the subjective expected utility for each alternative (sum of each option value x probability of state)
Axiomatic theory
normative theory is an axiomatic theory
example axioms:
- decidability; one must be able to decide between options
- transitivity; if a > b & b > c then a > c
- invariance; underlying structure, not surface structure. in other words the same question asked in different ways should yield the same answer.
- independence of utility and probability; how important an event is to you should not influence your judgement of how likely it is.
conclusions from normative decision theory
provides the rational solution for a decision
• offers terms in which decisions can be conceptualised
• shows how the best course of action can be derived in a System 2 manner
• produces highly influential models
But:
• Does it describe how we make decisions?
• If people do not decide like this, are they irrational?
system 1 thinking attributes
fast unconscious automatic everyday decisions error prone
system 2 thinking attributes
slow conscious effortful complex decisions reliable
What is limited capacity processing and how does it impact decision making
Capacity is limited in terms of amount and speed of processing
Information decays over time unless we rehearse it
But rehearsing also uses capacity and doing this while carrying out other computations is difficult
If we cannot register and rehearse two five-digit numbers what about decision making!?
These limitations and how we cope with them crucially affect how we think and the accuracy of this thinking in decision situations
George Miller on limited capacity processing
George Miller
Short term memory has three key aspects:
1. limited capacity (only about 7 items can be stored at a time)
2. limited duration (storage is very fragile and information can be lost with distraction or passage of time)
3. encoding (primarily acoustic, even translating visual information into sounds).
There are two ways in which capacity is tested, one being span, the other being recency effect.
The Magic number 7 (plus or minus two) provides evidence for the capacity of short term memory. Most adults can store between 5 and 9 items in their short-term memory. This idea was put forward by Miller (1956) and he called it the magic number 7. He though that short term memory could hold 7 (plus or minus 2 items) because it only had a certain number of “slots” in which items could be stored.
However, Miller didn’t specify the amount of information that can be held in each slot. Indeed, if we can “chunk” information together we can store a lot more information in our short term memory.
Herbert Simon on limited capacity processing
Herbert Simon:
Economic models make unrealistic assumptions
They assume unbounded rationality
How do people cope with cognitive limitations (limited capacity processing)
- use system 2 thinking, engaging in systematical, analytical, conscious, rule based thought.
- use system 1 thinking (simplify), simplify so you can think within capacity limitations
- use system 1 thinking (match to past experience)
Why use system 2 thinking?
People can be motivated to engage in System 2 if something is important enough to expend energy on
Having sufficient time is another reason – people often revert to system 1 when under pressure.
It is also important that decision makers have appropriate information available.
Why use/not use system 1 thinking (simplify)?
When we satisfice we don’t get the best, but we do get something adequate.
E.g. “Satisficing” choose first reasonable option (Simon, 1956)
There is always a trade off between the value of the decision and the time it would take. Problems arise if you don’t see this explicitly, particularly if you try to weigh all options, fail and then pick something inappropriate when confused by the situation or in a panic due to time pressure
Simpler and leads to resolution in the time allowed
Can use even simpler strategies, eg. recognition rule, You might go for brands you know or recognise when you buy something new like a phone or a tv. Gigerenzer also puts forward a simple rule of “if you recognize one object but not the other assume the first has a higher value”.
why use/not use system 1 thinking (match to past experience)
Try to recognise current situation from past experience and do what worked before
People store past instances AND actions for dealing with them
BUT for this to work you need expertise. You recognize things you have learned or experienced. You aren’t trying to think of what could be wrong – you know.
Many situations you face as a manager don’t really have a good match to many previous examples.
problems with system 1 (simplify)
People adopt System 1 to deal with situations without recognising its impact on the quality of decision making
While System 1 thinking is generally quite efficient it has the potential for catastrophe in some situations (i.e. where the environment not forgiving of error)
It’s difficult to defend choice because the decision maker has only fleeting knowledge of what they did.
A basic problem is knowing whether a previous decision was a good one (as in the previous example, with the credit managers).
problems with system 1 (matching using experience)
Doing so against past, not present and future. Sudden changes such as increased threat of terrorism not taken account of in past experience - the usual action takes no account of changes.
People are actually evolved for pattern recognition thereby mismatching and minimising differences between situations
Matching after just limited experience – inappropriate categorisation and response links
problems with system 2 thinking
Effortful
Time consuming
Detracts from other tasks
May not have the skills / know the process to follow
interaction between system 1 and 2
Kahneman and Frederick (2002)
The two systems operate in parallel
S2 monitors output of S1 to determine whether acceptable or if it needs to step in to modify, correct or change.
System 2 thinking needs attention and self control – these need energy and there are real world implications if this is depleted.
bat and ball problem - suggests that people who considered the intuitive response first but were able to overcome it are more aware of the difficulty of the problem. (Frederick 2005)
