Maps of Bounded Rationality: Psychology for Behavioral Economics
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In this presentation, you will be introduced to one of the masterpieces of Daniel Kahneman and Amos Tversky, in which they have explained human's bounded rationality in decision making and judgments. This work presents the two-system view of cognition which consists of intuition and reasoning and describes their differences in terms of their process and content in our judgments.
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Maps of Bounded Rationality: Psychology for Behavioral Economics
- 1. Maps of Bounded Rationality Psychology for Behavioral Economics By: Erfan MORADIAN December 2017
- 2. Daniel Kahneman Born on March 5, 1934 Israeli-American psychologist Nobel Memorial Prize in Economics, 2002 Seventh most influential economist in the world 2
- 3. Daniel Kahneman Best selling book, 2011 Senior scholar and faculty member emeritus at Princeton University Known for Cognitive Biases Behavioral Economics Prospect Theory Loss Aversion 3
- 5. Introduction Exploration of the psychology of intuitive beliefs and choices Examination of their bounded rationality A perspective on three major topics I. Heuristics of judgment II. Risky choice III.Framing effects 5
- 6. Introduction Intuitions Thoughts and preferences that come to mind quickly and without much reflection 6
- 8. Introduction Intuition and Accessibility Framing Effects Prospect Theory Attribute Substitution The Accessibility of Corrective Thoughts Prototype Heuristics 8
- 9. Intuition and Accessibility What is the difference between Intuition and Reasoning 9
- 11. The two-system view Intuition or System 1 Fast Parallel Automatic Effortless Associative Slow-learning Operational Characteristics 11
- 12. The two-system view Reasoning or System 2 Slow Serial Controlled Effortful Rule-governed Flexible Operational Characteristics 12
- 13. The two-system view Perception Intuition System 1 Reasoning System 2 Slow Serial Controlled Effortful Rule-governed Flexible Fast Parallel Automatic Effortless Associative Slow-learning Percepts Current stimulation Stimulus-bound Conceptual representations Past, Present and Future Can be evoked by language ProcessContent 13
- 14. The two-system view The perceptual system and the intuitive operations of System 1 generate impressions of the attributes of objects of perception and thought. These impressions are not voluntary and need not be verbally explicit. 14
- 15. The two-system view Judgments are always explicit and intentional. System 2 is involved in all judgments. The label ‘intuitive’ is applied to judgments that directly reflect impressions. 15
- 16. Cognitive Self-monitoring A bat and a ball cost $1.10 in total. The bat costs $1 more than the ball. How much does the ball cost? 16
- 17. The surprisingly high rate of errors in this easy problem illustrates how lightly the output of System 1 is monitored by System 2. People are not accustomed to thinking hard. They are often content to trust a plausible judgment that quickly comes to mind. 17
- 18. The accessibility dimension The core concept of intuitive judgments and preferences The ease with which particular mental contents come to mind e.g category labels, descriptive dimensions (attributes, traits), values of dimensions, etc. 18
- 19. The accessibility dimension A B C 19
- 21. The accessibility dimension Accessibility is a continuum, not a dichotomy, and some effortful operations demand more effort than others. The acquisition of skill selectively increases the accessibility of useful responses and of productive ways to organize information. 21
- 22. Determinants of accessibility Genetic differences Expectations Context Properties and presentation of the object Familiarity with the perceived object (associative activation) Emotional significance, e.g. Investments based on the degree of likeness, insurance based on fear concerns. 22
- 26. Determinants of accessibility Natural assessments Attributes which are routinely and automatically registered by the perceptual system or by System 1, without intention or effort. Attributes that come to mind without intention or effort. 26
- 27. Determinants of accessibility Natural assessments Physical properties such as size, distance and loudness Similarity Affective valence Causal propensity Surprisingness Mood Accessibility 27
- 28. Framing Effects Imagine that the United States is preparing for the outbreak of an unusual Asian disease, which is expected to kill 600 people. Two alternative programs: If Program A is adopted, 200 people will be saved If Program B is adopted, there is a one-third probability that 600 people will be saved and a two-thirds probability that no people will be saved Which of the two programs would you favor? 28
- 29. Framing Effects A different description of the options: If Program A’ is adopted, 400 people will die If Program B’ is adopted, there is a one-third probability that nobody will die and a two-thirds probability that 600 people will die 29
- 30. Framing Effects Extensionality (Invariance): The assumption that preferences are not affected by inconsequential variations in the description of outcomes. Framing Effect: Where extensionally equivalent descriptions lead to different choices by altering the relative salience of different aspects of the problem. Very important when considering policy Basic principal of framing is the passive acceptance of the formulation given 30
- 31. Prospect Theory A general property of perceptual systems is that they are designed to enhance the accessibility of changes and differences. Perception is reference-dependent: The perceived attributes of a focal stimulus reflect the contrast between that stimulus and a context of prior and concurrent stimuli. 31
- 33. Prospect Theory Would you accept this gamble? 50% chance to win $150 50% chance to lose $100 Would your choice change if your overall wealth were lower by $100? 33
- 34. Prospect Theory Which would you choose? lose $100 with certainty or 50% chance to win $50 50% chance to lose $200 Would your choice change if your overall wealth were higher by $100? 34
- 35. Prospect Theory An alternative theory of risk The carriers of utility are gains and losses Changes of wealth rather than states of wealth. Preferences are reference-dependent, and includes the extra parameter that is required by this assumption. 35
- 36. Bernoulli’s error The assumption that the carriers of utility are final states The error of reference-independence is built into the standard representation of indifference maps. 36
- 37. Value Function for Changes 37
- 38. Value Function for Changes Preferences are determined by attitudes to gains and losses, defined relative to a reference point. The value of the function is kinked at the reference point. Convex in the domain of gains, favoring risk aversion Concave in the domain of losses, favoring risk seeking 38
- 39. Prospect Theory Two persons get their monthly report from a broker: A is told that her wealth went from 4M to 3M B is told that her wealth went from 1M to 1.1M “Who of the two individuals has more reason to be satisfied with her financial situation?” “Who is happier today?” 39
- 40. Prospect Theory In Bernoulli’s analysis only the first of the two questions is relevant. long-term consequences matter. Prospect theory, in contrast, is concerned with short- term outcomes. 40
- 41. Attribute Substitution: A Model of Judgment Heuristics People rely on a limited number of heuristic principles which reduce the complex tasks of assessing probabilities and predicting values to simpler judgmental operations. 41
- 42. Attribute Substitution A formulation in which the reduction of complex tasks to simpler operations is achieved by an operation of attribute substitution 42
- 43. Attribute Substitution Judgment is said to be mediated by a heuristic when the individual assesses a specified target attribute of a judgment object by substituting another property of that object which comes more readily to mind 43
- 44. Attribute Substitution What are the sizes of the two horses? 44
- 45. Attribute Substitution 1- “How happy are you with your life in general?” 2- “How many dates did you have last month?” 45 Correlation = 0.12
- 46. Attribute Substitution 1- “How many dates did you have last month?” 2- “How happy are you with your life in general?” 46 Correlation = 0.66
- 47. Attribute Substitution Affect (liking or disliking) is the heuristic attribute for numerous target attributes, including the evaluation of the costs and benefits of various technologies 47
- 48. Attribute Substitution A technology that is liked is judged to have low costs and large benefits. These judgments are surely biased, because the correlation between costs and benefits is generally positive in the world of real choices 48
- 49. Attribute Substitution Different responses to public goods (e.g., willingness to pay, ratings of moral satisfaction for contributing) yielded essentially interchangeable rankings of a set of policy issues 49
- 50. Attribute Substitution People's decisions often express affective evaluations (attitudes), which do not conform to the logic of economic preferences 50
- 51. Attribute Substitution The preferences of System 1 are not necessarily consistent with the preferences of System 2 51
- 52. Prototype Heuristics Prototype heuristics share a common psychological mechanism - the representation of categories by their prototypes - a remarkably consistent pattern of biases 52
- 53. Prototype Heuristics Whenever we look at or think about a set (ensemble, category) which is sufficiently homogeneous to have a prototype, information about the prototype is automatically accessible 53
- 54. Prototype Heuristics Whenever we look at or think about a set (ensemble, category) which is sufficiently homogeneous to have a prototype, information about the prototype is automatically accessible 54
- 55. Prototype Heuristics The prototype of a set is characterized by the average values of the salient properties of its members 55
- 56. Prototype Heuristics The low accessibility of sums and the high accessibility of prototypes have significant consequences in tasks that involve judgments of sets 56
- 57. Prototype Heuristics i) Category prediction ii) Pricing a quantity of public or private goods iii) Global evaluation of a past experience that extended over time iv) Assessment of the support that a sample of observations provides for a hypothesis 57
- 58. 58 Prototype Heuristics Target Attribute Heuristics Attribute Extensional A characteristic of the category prototype
- 59. Prototype Heuristics Two major biases, which generalize the biases of representativeness: Violations of monotonicity Extension neglect 59
- 60. Violations of monotonicity Adding elements to a set may lower the average and cause the judgment of the target variable to decrease, contrary to the logic of extensional variables 60
- 61. Extension neglect Other things equal, an increase in the extension of a category will increase the value of its extensional attributes, but leave unchanged the values of its prototype attributes 61
- 62. The Boundaries of Intuitive Thinking The judgments that people express, the actions they take, and the mistakes they commit depend on the monitoring and corrective functions of System 2, as well as on the impressions and tendencies generated by System 1 62
- 63. Intuitive Judgement is impaired by: Time pressure Concurrent involvement in a different cognitive task Performing the task in the evening for "morning people" and in the morning for "evening people" Being in a good mood 63
- 64. The facility of System 2 is positively correlated with: Intelligence Need for cognition Exposure to statistical thinking 64