Choice (decision making)

Question 1

What are heuristics?

Answer 1

• Mental short-cuts that allow us to skip careful deliberation to draw an inference

Question 2

What are the 2 types of reasoning systems?

Answer 2

• system 1: fast
• system 2: slow

Question 3

What is system 1?

Answer 3

• fast
• heuristic based reasoning
• easy, automatic

Question 4

What is system 2?

Answer 4

• slow
• serial logical analysis of information
• weighing the pros and cons
• effortful, non automatic, deliberate, methodical

Question 5

What is a bias?

Answer 5

• deviations from rationality (errors) that are caused by using heuristics

Question 6

What is the availability heuristic?

Answer 6

• A heuristic in which we estimate the probability of an event based on the ease at which it can be brought to mind

Question 7

What is the affect heuristic?

Answer 7

• The tendency to overestimate the risk of an event that generates strong emotional response
• why some things come to mind easier than others
• Sunstein (2002): People rate sharks as one of the most dangerous animals, especially after being exposed to media about shark attacks, Yet people are much more likely to die from bees or wasps than sharks

Question 8

What is the representativeness heuristic?

Answer 8

• People tend to make inferences on the basis that small samples resemble the larger population they were drawn from
• Related to the availability heuristic: Relies on stereotypes, schemas, and other pre-existing knowledge structures
• People base their judgements of group membership based on similarity
• This results in biases like base-rate neglect & the conjunction fallacy

Question 9

What is base rate neglect?

Answer 9

• When you fail to use information about the prior probability of an event to judge the likelihood of an event

Question 10

What is conjunction fallacy?

Answer 10

• False belief that the conjunction of two conditions is more likely than either single condition
• The likelihood of an event is always higher than the likelihood of that event and something else

Question 11

What is anchoring?

Answer 11

• The tendency for people to overweight initial information when making decisions
• Anchoring is particularly important for designing self-report scales

Question 12

What is regression toward the mean?

Answer 12

• When a process is somewhat random (i.e. weak correlation), extreme values will be closer to the mean (i.e. less extreme) when measured a second time
• This is not a fluke; this is a statistical necessity
• Can’t always attribute changes in performance to manipulations

Question 13

What is bounded rational?

Answer 13

• The theory that humans are rational relative to environmental constraints (e.g. time pressure) and individual constraints (e.g. working memory, attention)
• People are Satisficers: we look for solutions that are “good enough”
• “Making do” with the limitations we have as humans
• Although heuristics sometimes provide incorrect answers and lead to biases; they also work

Question 13

Which of the following is not true about Heuristics and biases?

a. Base rate neglect is an example of anchoring
b. Regression towards the mean only happens where there is not a perfect correlation
c. Heuristics sometimes can give the right answer
d. People use heuristics because we are boundedly rational

Answer 13

a

Question 14

What is ecological rationality?

Answer 14

• The view proposed by Gerd Gigerenzer (1999) which sees heuristics not as a “good enough” approach to solving a problem but as the optimal approach
• A heuristic is the best solution to a particular problem; what is the best way for me to answer this question, given all of my constraints
• Given the right environment, a heuristic can be better than optimization than other complex strategies
• Sometimes heuristics (give the right circumstances) can be better than complex strategies

Question 15

What are the types of decision making?

Answer 15

• perceptual
• value based
• risky

Question 16

What is perceptual decision making?

Answer 16

• Objective (externally defined) criterion for making your choice
• Are the dots moving left or right?

Question 17

What is value based decision making?

Answer 17

• Subjective (internally defined) criterion for making your choice
• Do I want cake or ice cream for dessert?
• Depends on motivational state and goal

Question 18

What is risky decision making?

Answer 18

• decisions under risk
• decisions when outcomes are uncertain
• ambiguity: when you have incomplete information about the consequences
• When outcomes are uncertain, we still need to decide
• Extremes in risk taking (high or low) can be very harmful
• Risks can be framed as gains and losses
• Most people are risk averse (don’t’ like making risky decisions)

Question 19

What are the risk attitude profiles?

Answer 19

• risk averse
• risk neutral
• risk seeking

Question 20

What is risk premium?

Answer 20

• Difference between expected gains of a risky option and a certain option
• How much better risky option is

Question 21

What is risk averse?

Answer 21

• Decision maker has positive risk premium
• Need a chance at winning a lot more than a certain option to select the risky option
• high risk premium to choose risky option

Question 22

What is risk neutral?

Answer 22

• Decision maker has zero risk premium
• No difference in the options
• don’t see one option as better than the other

Question 23

What is risk seeking?

Answer 23

• Decision maker has negative risk premium
• Doesn’t need the chance at winning more than the certain option to gamble
• in it for the thrill

Question 24

Are risk preferences rational?

Answer 24

• Classical economic theory explained rational choice in terms of expected value
• The rational thing to do is choose the option that maximizes expected value
• So classical (rational) economic theories can account for individuals’ risk preferences
• However, it has been empirically observed that people are inconsistent in their preferences which has been taken as a bias
• We do not follow expected value
• The question for the behavioural economist then is not how should people act, but how do people act?

Question 25

What is the framing effect?

Answer 25

• The display of inconsistent risk preferences depending on the framing (loss vs gains) of the problem
• People are risk averse when the options are described as gains; They prefer the sure thing and go for safety
• People are risk-seeking when the options are described as losses; They can tolerate an uncertain thing and risk a loss

Question 26

What is the endowment effect?

Answer 26

• The tendency to ascribe higher value to objects people own or possess compared to identical objects they do not own
• Another case in which the framing of the decision matters
• Once ownership is established, people are averse to give it up

Question 27

What is prospect theory?

Answer 27

• A psychological theory that explains how people make decisions under uncertainty
• Kahneman & Tversky
• Two major features: shape of utility function (gains vs losses) and shape of probability weighting function (unlikely vs likely events)
• Describes how people do act; not how people should act
• The birth of Behavioural Economics

Question 28

What is utility?

Answer 28

• Subjective value assigned to an object (i.e.
  satisfaction)
• Context dependent
• Utility is assigned to a monetary amount as a function of someone’s current state (reference point) and not in absolute value
• Deviations from the reference point will determine risk preference
• Anchor and Adjustment heuristic

Question 29

What is the utility function?

Answer 29

• Describes how people map money to utility
• The extra utility earned from gaining a dollar is larger when you only have $1 vs when you have $1M (utility depends on context)
• Utility for losses versus gain is asymmetrical
• The utility function is steeper for losses than gains
• $1 lost hurts more than $1 earned
• Losses loom larger than gains (framing effect)

Question 30

What is probability weighting?

Answer 30

• According to PT, people do not treat probabilities in an objective manner
• Extreme events tend to be rare
• Extremity of event related to perceived probability
• Unlikely events are overestimated
• Likely events are underestimated
• Availability of an option changes the perceived frequency of occurrence (availability heuristic)

Question 31

What is the fourfold pattern?

Answer 31

• High probability + losses = risk seeking
• High probability + gains = risk averse
• Low probability + losses = risk averse
• Low probability + gains = risk seeking

Question 32

What is dual process theory?

Answer 32

• The broad scientific theory that that humans posses two systems for making decisions
• Participants provided higher estimates of death frequency when people were in a negative mood compared to a positive mood

Question 33

What are the 2 systems in dual processing?

Answer 33

System 1:
- Fast, effortless, automatic, intuitive, emotional
- Heuristics and biases
- Limbic System

System 2:
- Slow, deliberative, Effortful, explicit, logical
- Rational choice
- Frontal cortex

Question 34

What is prediction error?

Answer 34

• The difference between what you predicted would happen and what actually happened
• Prediction errors can be positive or negative
• Prediction errors can drive people’s mood and affect real-world risk attitudes

Question 35

What is a positive prediction error?

Answer 35

• Unexpectedly good outcome
• increases positive affect

Question 36

What is a negative prediction error?

Answer 36

• Unexpectedly bad outcome
• increases negative affect

Question 37

Which of the following statements about Prospect Theory is false?

a. It tells us how people do act instead of how they should act
b. The asymmetry of the utility function accounts for the framing effect
c. People tend to overestimate the probability of rare events and underestimate the probability of common events
d. The utility of an option depends on how much it is worth, in an absolute sense

Answer 37

d