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# Introduction to decision making

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A first lecture in basics of human decision making

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### Introduction to decision making

1. 1. Introduction to Decision Making Sumitava Mukherjee sumitava.inbox@gmail.com 1
2. 2. Which is the best cell phone according to you? 2
3. 3. Should I marry? (Darwin’s thoughts)MARRY NOT MARRYCHILDREN NO CHILDRENCONSTANT COMPANION FREEDOMCHARMS OF A FEMALE CHIT-CHAT MEN’S CLUB CONVERSATIONSTAKE CARE OF HOUSE AND MYSELF NOT FORCED TO VISIT RELATIVESPICTURE OF NICE EVENING ON A SOFA WORKING TOO MUCH NOT GOOD BUT MORE MONEY FOR BOOKS! 3
4. 4. Press a key..HHHHHHHHHHNHHHHHHHHHHPress <- if you see a N in the center and -> if not 4
5. 5. What kind of a face is it?Press <- if the face was happy and -> if not 5
6. 6. What is more probable?• If you flip a coin having an equal chance of landing on tails and an equal chance of landing on heads, which is more likely?[1] H T T H T H[2] H H H T T T[3] H T H T H T[4] H H H H H T 6
7. 7. Q: What is a decision?“A decision is a commitment to a course ofaction that is intended to produce a satisfyingstate of affairs” (Yates et al., 2003) Q: What is a good decision? •Based on outcome : Good outcome = Good decision •Time to recall: Good decisions slower 7
8. 8. Formal decision theory: The broad framework• A choice scenario• Set of potential actions• Set of possible (probabilistic) outcomes• Basic prediction: find an action such that there is a tradeoff between the costs and probabilities of the outcomes vs the preferred outcome Ex., Neumann & Morgenstern, 1944 8
9. 9. Decision sciences before 1950s: Gambles & Expected value• Expected value: You win 100Rs if after a coin toss, you get head else you get zero. Expected Utility = 0.5x100 + 0.5x0 = 50 Rs.• Economists used expected utility to describe how decisions should be made and how “econs” decide.• What about “humans”? 9
10. 10. Bernoulli’s insight (1738)• Gustav Fechner: Subjective quantity in mind with objective measurement (Brightness)• Subjective utility: Psychological value or desirability of money• Psychological response is inversely related to initial wealth 10
11. 11. Bernoulli : Expected Utility• People’s choices are not based on dollar values but on psychological values of their outcomes• Utility is a logarithmic function of wealth• Diminishing marginal value of wealth Wealth: 1,2,3,4,5,6,7,8 Utility units: 10,30,48,60,70,78,84,90Equal chances of winning 1 million or 8 million Vs winning 4 million for sure? Expected value vs expected utility Premium? 11
12. 12. Bernoulli’s Error• Today Asma and Anjali have 5 lakh. Yesterday Asma had 1 lakh and Anjali had 9 lakh.Are they equally happy? (Do the sums of money have the same utility).Bernoulli’s prediction: Yes. Happiness is dependent on the utility of their wealthChange in wealth matters! 12
13. 13. Bernoulli’s error• Antony owns 1 million, Betty owns 4 million• Both offered gambles of (a) an equal chance to own 1 million or 4 million vs (b) own 2 million for sure.• Bernoulli’s prediction: People choose the sure option• Reference point matters!• Can explain Antony’s risk aversion, but not Betty’s risk seeking 13
14. 14. Prospect Theory Not initial wealth but a change in wealth Evaluation is relative to the reference point Pos above ref = gains Neg below ref = losses Diminishing sensitivity Loss AversionProposed by Amos Tversky & Daniel Kahneman -Won 2002 Nobel prize in economics 14
15. 15. Modes of thoughtWe are not calculators! 15
16. 16. What kind of a face is it? 16
17. 17. What is the value of? 17x24 17
18. 18. Modes of thought Dual systems perspectiveSYSTEM 1 (intuition) SYSTEM 2 (Deliberation)Almost automatically ControlledNo/less effort More effortAssociative SerialImplicit ExplicitMore emotional CalculativeFast Slower Stanowich & West, 2000; Kahneman, 2002; 2011 18
19. 19. Heuristics & Biases• Anchoring & AvailabilityIs the height of the tallest redwood more or less than 1200 (180) feet?What is your best guess? System 1 vs System 2 S2 works on information cued in memory by S1 S2 is biased by anchors induced by S1 19
20. 20. Heuristics & Biases?• Insensitivity to probability distributions Is it more likely that you shall be killed by falling airplane pieces or by sharks (if you were in Australia)?• Diversification heuristics (Simultaneous vs sequential choice of snacks, Simonson, 1990)• Hindsight (I always knew it!) 20
21. 21. Heuristics and Biases:presentation format 0.0001% Vs 1 out of 1000000 Lindsey, Hertwig & Gigerenzer, 2003 21
22. 22. Class Q: Which is more probable?• Ram had one or more heart attacks• Ram is 70 years old and has suffered one or more heart attacks 22
23. 23. Take homes• Econs vs Humans• Expected value, expected utility, Bernouli, Prospect Theory• Modes of thought – System 1 vs System 2• Heuristics and biases is part of life• Too many choices is not always great 23
24. 24. General Readings• For general topics, see the chapters on thinking, reasoning and problem solving from your textbooks• A nobel prize in economics goes to a psychologist in decision making – Daniel Kahneman : http://www.forbes.com/2002/11/06/cx_da_1106 nobel1.html• Too many choices in life?: http://www.nytimes.com/2010/02/27/your- money/27shortcuts.html 24
25. 25. Videos• Are we in control of our decisions? http://www.youtube.com/watch?v=9X68dm92HVI (Dan Ariely)• Riddle between experience and memory: http://www.youtube.com/watch?v=XgRlrBl-7Yg (Daniel Kahneman)• Paradox of choice: http://www.youtube.com/watch?v=VO6XEQIsCoM (Barry Schwatrz)•See http://www.youtube.com/watch?v=VO6XEQIsCoM for paradox of choiceand also http://www.youtube.com/watch?v=lDq9-QxvsNU for art of choosing 25