Topic 2: Judgment Under Risk and Uncertainty Flashcards
The standard economic assumption has been that people
make decisions under uncertainty optimally, that is, they
use the …. .. …………. ……
laws of probability theory
Uncertainty
we do not know some of the possible
outcomes or how likely they are
Risk
we know possible outcomes and how likely they
are.
A heuristic
A heuristic is a rule of thumb or mental shortcut: useful
because it reduces the effort required to form a judgment
but dangerous because it can lead to a bias
Tversky and Kahneman’s viewpoint is that there are two
interacting systems in cognition:
System 1: The intuitive system uses heuristics that sometimes get things wrong from the point of view of conscious
reasoning; but it is fast, automatic, effortless, and difficult
to control or modify. It is adaptive because it gets things
approximately right when it is important to act quickly.
System 2: Conscious reasoning is a slow but sophisticated
process that is very flexible and can be changed and improved
by learning; but it can only concentrate on one thing at a
time, and it requires effort and control.
We will discuss three heuristics:
- Representativeness
- Insensitivity to prior probability
- Insensitivity to sample size
- Conjunction (and disjunction) Fallacy - Anchoring and Adjustment
- Availability
if people evaluate probabilities by representativeness,
prior …………… will be neglected
probabilities
Base rate
Prior probability. In the example, the fraction of all the individuals in the population who have HIV (or some other characteristic of interest).
Base rate neglect
Failing to take into account the base rate leads people to overestimate the possibility of this person having HIV in our example.
Representativeness can lead to neglecting important parts of
the Bayes rule such as the …. …. P(Hypothesis).
base rate
Even when the heuristic has some validity, exclusive reliance
on it may be ………
misleading
People mistakenly apply the idea of the law of large numbers
to ….. samples. This is called the law of small numbers
small
Gambler’s fallacy
mostly due to a mistaken belief that two outcomes are dependent even though they are not. Like if you get head 6 times in a row you might believe that tails is more likely to come next in a coin toss.
Hot hand fallacy
Hot hand fallacy refers to the belief among basketball fans that a player’s chance of hitting a shot is greater following ahit than following a miss on the previous shot.
Similar to gambler’s fallacy in the sense that two independent events are considered dependent
The conjunction fallacy
The conjunction fallacy is an inference that a conjoint set of two or more specific conclusions is likelier than any single member of that same set, in violation of the laws of probability. People tend to overestimate the probability conjuctive events
Disjunction Fallacy
this fallacy occurs when one estimates a disjunctive statement (this or that) to be less probable than at least one of its component statements. People tend to underestimate the probability disjunctive events
anchoring
People begin the process of estimation with whatever information readily appears in their mind
adjustment
They then reassess their initial answers based on rough notions of what is a not-too-silly answer
It is possible to influence the figure you will choose in a particular situation by ever-so-subtly suggesting a starting point (anchor) for your anchoring-and-adjustment rule of thumb. This is an example of ……….
nudging (nudges)
Research shows that people tend to ………… the probability of conjunctive events and to ………… the probability of disjunctive events. Anchoring is to blame.
overestimate/underestimate
The overall probability of a ……….. event is lower than the success probability at each stage: overestimation
conjuctive
The overall probability of a ……….. event is higher than
the success probability at each stage: underestimation
disjunctive
Biases in the evaluation of compound events are particularly
significant in the context of ………….
- The successful completion of the development of a new product typically has a conjunctive character: for the undertaking to succeed, each of a series of events must occur.
Even when each of these events is very likely, the overall probability of success can be quite low if the number of events is large.
Chain-like structure of conjunctions leads to overestimation, so unwarranted
optimism in the evaluation of the likelihood that a plan will succeed
planning
Disjunctive structures are typically encountered in the evaluation of …..
- A complex system, such as a nuclear reactor, will malfunction if any of its essential components fails.
Even when the likelihood of failure in each component is slight, the probability of an overall failure can be high if many components are involved.
The funnel-like structure of disjunctions leads to underestimation of the probabilities of failure in complex system.
risks
Availability
People often assess the frequency of a class or the probability of an event by the ease with which instances or occurrences can be brought to mind
Heuristics and biases
functional but imperfect mental shortcuts that approximate a solution with little deliberation cost, but have the potential to make systematic errors
