Strategy and Decision Making Flashcards
What are the assumptions of a rational decision maker?
Be able to identify all relevant options
Have complete information about the choice options
Maximize their utility
Take choices independently
Have consistent preferences
Bounded Rationality
People do not maximize their utility, they “satisfice”
Complex problems are reduced to a level at which they can be understood
Choice of a solution that is good enough rather than optimal
It is much less costly in terms of time and energy
What does System 1 consist of?
Fast, intuitive
Operates automatically
Reliance on habits, emotions
(Often) effortless
It cannot be switched off
Availability bias
The availability bias describes our tendency to use information that comes to mind quickly and easily when making decisions about the future
Goal Asymmetry
Goal asymmetry is when team members have distinct goals (that may even conflict)
Informational Cascades
People silence themselves out of deference to the information conveyed by others
Not always irrational decision-making, sometimes it makes sense to follow others if no clear preference
Rational choice theory
Rational choice theory
A popular theory in political science to explain the actions of voters as well as politicians. It assumes that individuals act in their own best interest, carefully weighing the costs and benefits of possible alternatives.
What are the important points of Rational Choice Theory?
What are the important points of Rational Choice Theory?
Rely on rational calculations when evaluating their options
Perform a cost-benefit analysis
Pursue the ultimate aim to maximize their self-interest
What are consistent preferences?
What are consistent preferences?
Complete and Transitive (logically coherent)
Rational Choice Theory: Strengths and Applications
Rational Choice Theory: Strengths and Applications
It can help to explain and predict behaviors
Provides a rational benchmark to compare real choices to
Applicable to many different areas (Investment decisions / consumer behavior)
Rational Choice Theory: Criticism
Rational Choice Theory: Criticism
There is no way of knowing all choices and their characteristics
Individuals have limited time and cognitive resources
Decisions can be based on emotions rather than rationale reasoning
Decision problems can be too complex for individuals to solve
Other individuals or groups influence our decision-making
What are the 2 systems of thinking?
What are the 2 systems of thinking?
System 1: Intuition and Instinct (95%): unconscious, fast, associative, automatic
System 2: Rational Thinking (5%): takes effort, slow, logical, lazy, indecisive
What does System 2 consist of?
What does System 2 consist of?
Slow, deliberate
Operates only when activated (low-effort mode)
Shaped by data, evidence
Requires effort
When does System 2 activate?
When does System 2 activate?
System 2 activates when System 1 encounters tasks that
Requires excessive attention or Deviates from System 1’s familiar context
What are the downsides of System 1?
System 1 is proficient in its operations, BUT Is subject to biases Has a limited grasp of logic and statistics
Which system falls for illusions?
1
Expected Value Theory
Get the highest expected value
(Probability obtain) X (value)
Expected Value Formula
E(x)=(p1X1)+(p2X2)…
Expected Utility Theory
people make decisions by considering the possible alternatives and choosing the most desirable one
Advantages of the Expected Utility Theory
Extends to any type of good (not just monetary value)
Decreasing marginal utility u’(x) (via concave function)
Incorporates risk aversion
Men vs. Women Risk Aversion
On average women do take less risk
But the difference is pretty small
There are more variations within than between gender
Prospect Theory
theory that suggests that a decision, or argument, can be framed in different ways and that the framing affects risk assessments consumers make
Not a theory for guiding behavior, but for explaining and making accurate predictions on behavior
How does a person’s value function look like?
People have an asymmetric value function
Defined in changes of wealth
Evaluation is relative to a neutral reference point (Adaptation level)
Incorporates not only gains but also losses
People are loss-averse
Losses weigh heavier than gains
How do people deal with gains and losses?
People are risk-averse for gains, but risk-seeking for losses
Diminishing Sensitivity
more sensitive to changes near the reference point than far from the reference point
The difference between 900 and 1000 feels smaller than the difference between 100 and 200
3 Main Reference Points in Prospect Theory
Often the status quo
The outcome that you expect
Outcomes you feel entitled to
If outcome > reference point = gain
If outcome < reference point = Loss
Lessons from Prospect Theory
When making a decision, reframe it from gains to losses and vice versa and see how it affects your preference
Bundle bad news
Recall that expectations are a reference point for people
Experiencing losses is demotivating
Anticipating potential losses can be very motivating
Overconfidence
the tendency to be more confident than correct—to overestimate the accuracy of our beliefs and judgments.
how to overcome overconfidence?
Train on past cases where outcomes are known
Explicitly consider competing hypotheses
Gather a group of knowledgeable people just before making a decision
Compromise Effect
Adding an extreme alternative increases the preference for the middle product
Perceived as lowest risk (Safe bet)
Easy to justify
Combination of Option A and C
Attraction Effect
Decision makers select the alternative that is supported by the best reasons
Thus individuals do not necessarily choose the option with the highest utility. instead, they choose the option that fares best when compared with others.
The Anchor Effect
a cognitive bias that describes the common human tendency to rely too heavily on the first piece of information offered when making decisions
Example: Groups who are presented with high anchor numbers will give estimates that are significantly higher than those who were presented with lower anchor numbers
2 Different mechanisms produce anchor effects
Insufficient Adjustment
Enhanced Accessibility
Insufficient Adjustment
Insufficient Adjustment
people adjust from anchor (effortful operation), and stop adjusting when they are no longer certain
Enhanced accessibility
also known as the priming effect of anchor-consistent information, the anchor works as a suggestion
Availability Cascade
A self-reinforcing process in which a collective belief gains more and more plausibility through its increasing repetition in public discourse (or “repeat something long enough and it will become true”).
An initial media report on a minor incident can provoke public panic, leading to increased media coverage
Mental Accounting
categorizing spending and saving decisions into “accounts” mentally designated for specific consumption transactions, goals, or situations
How do status and hierarchy affect group performance?
Higher-status individuals better resist conformity pressures
With too many high-status individuals group performance suffers
Surface Level Diversity
Surface Level Diversity
differences such as age, sex, race/ethnicity, and physical disabilities that are observable, typically unchangeable, and easy to measure
Deep-level diversity
Deep-level diversity
differences such as personality and attitudes that are communicated through verbal and nonverbal behaviors and are learned only through extended interaction with others
Diversity Benefits vs. Drawbacks
Benefits
➢ Pools a broader base of information & knowledge
➢ Increases divergent thinking
➢ Increases open-mindedness and creativity
Costs
➢ Increased group conflict
➢ Lower levels of satisfaction and group morale
Information Asymmetry
situation in which one party is more informed than another because of the possession of private information
Information Sharing Bias
Groups tend to focus on and share information that is commonly held by their members
But spend less time disclosing information that is privately held
This preference can hinder the group’s ability to consider all relevant information and make the best decision
Wisdom of Crowds
The idea that a group of individuals (the crowd), often consisting of untrained amateurs, will collectively have more insight than a single or small group of trained professionals.
Conformity Bias
Tendency for social psychology to treat group influence as a one-way process in which individuals or minorities always conform to majorities.
Asch Experiment
Participants had to match a target line to one of the lines shown on a separate card
How can group decisions be manipulated?
Researchers demonstrate that popularity influences others’ tastes, for example, music preferences
Similar groups may end up making very different judgments simply because of who spoke first
Group Polarization
tendency of group members to move to an extreme position after discussing an issue as a group
Anti Groupthink measures
As a leader, manage conflict productively rather than suppressing it!
Distinguish between cognitive and affective dissent
Make sure everyone gets a voice before the choice is taken
Discuss in sub-groups or 1:1; as a leader leave the room
Invite people to play the devil’s advocate
Delphi Method
Invite outsiders (e.g., audits)
Social Influence
the effect that the words, actions, or mere presence of other people have on our thoughts, feelings, attitudes, or behavior
Noise
Noise
anything that interferes with, distorts, or slows down the transmission of information
Bias
Bias
A particular preference or point of view that is personal, rather than scientific.
Error in Judgment
Error in (single) judgment = Bias + Noise
How to Measure Noise?
Measure noise with noise audit: give the same problems to different experts and measure differences in their responses
How to Reduce Noise?
Aggregate multiple independent judgments, different people making judgments independently, rather than assigning the judgment to one person
Define the scale on which a judgment is made, and replace an absolute scale with a relative scale
Use algorithms or rules of some kind, or artificial intelligence, to replace human judgment
