Steps in the decision process of a rational decision:
1.) Define the problem
2.) Identify all decision criteria
3.) Allocate weights to the criteria
4.) Identify all alternatives
5.) Evaluate the alternatives
6.) Choose the best alternative Bounded rationality = resources (time, cognitive) are limited)
We don’t always optimize our choices due to limited resources Predictable irrationality = we are not just often wrong, but systematically (biased) System 1 automatic, fast, not cognitively demanding, uncontrollable, associative memory.
System 2 controlled, slow, cognitively demanding, rule-based, deliberate, wilful. Rational answer.
Questions the answer of system 1. System 1 uses heuristics (mental shortcuts). These are efficient and work most of the time. When
they don’t work, they cause bias. However, not al biases arise due to heuristics/system 1. We rely
more on heuristics when there is more time pressure. Probability estimation = how do we make choices under chance.
Representativeness heuristic = the more X resembles Y, the more likely X is to be Y
(stereotypes). (when people have 4 kids, we assume 2 boys, 2 girls earlier than 4
girls). We underestimate the importance of information. We need to ask ourselves
how likely Y is in the first place, if it is very unlikely, the fact that X is Y is not very
likely too. The representative ignores the base rate, it overestimates certain
probabilities (conjunction fallacy). False positives (PowerPoint). There is often
misconception of chance. People think that after three times tails, heads is more
likely (gambler’s fallacy). Illusion of validity = if people have too much faith in their
own prediction while this is unjustified. Misconception of regression is that results
always return to the mean.
Availability heuristic = the more examples of X come to mind, the more likely X is. Bias in
memory door familiarity, recency (when you have heard something about it recent) or
salience (we inflate the change that something is going to happen by the speed it comes up
in our mind, like plane crash or motorbike). Effectiveness of a search set (we can think of
words that start with an r more easily than words that have an r as third letter). Imaginability
(it is easier to imagine different groups of 2 out of 10 people, that groups of 8). Illusory
correlation (people link 2 event to each other and thus think that when one thing is the case,
the other must be too).
Anchoring and (insufficient) adjustment = no heuristic but a bias. First pieces of information
overly matter. An anchor can influence the answer you give to a random following question
(number of African countries in UN after asking whether it is more than 10 or 60). Conjuctive
is overschatten van kansen, disjuctive het onderschatten.
Choice context effect = due to system 2. How the alternatives are presented can influence the
choice. This works because people are concerned about justifying their choices and system 2 uses
relative evaluations. People are more likely to choose an option from an attractive set. People prefer
options that are easier to comprehend. These effects works less when there is time pressure.
Attraction effect = add an option that is worse
than the 2 given option (normal paper for 10,-
paper online + normal for 15,- or paper online
Compromise effect = people tend to choose
the middle option. (When first presented with
small and medium they are indifferent. When
large is added, they choose medium.)
Enhancement effect = option does not have
an absolute advantage. Mental calculations
are needed to determine which option
provides better relative value. The better or enhanced options offers a better trade-off. (3
pens for 1,-, 5 for 1,50 and 7 for 2,30 5 is the better option since you pay less for 2 extra
pens). Thus a trade-off between X and Y makes Z more attractive.
Detraction effect = contrary to enhancement effect, trade-off between X and Y makes Z
An improvised option has an average value for everything. An enriched option has both negative and
positive features. Module 2
Choices are often made under uncertainty, there is a risk.
Expected value = sum of all possible values multiplied by the probability of occurrence. This doesn’t
describe how people make choices, that is done with expected utility.
Certainty equivalent = the certain amount that people find equivalent to the ‘risky’ option. When
people are risk averse, the CE is lower than the EV. For risk prone, the CE is higher than the EV.
Expected utility = people do not maximize normal value but a utility. This utility has diminishing
marginal utility. This can explain risk aversion. (EU (10,-) is higher than 0,5EU(10,-). )
In gain frame, people are loss averse. While in loss frame, people are risk seeking. Prospect theory = a value function with probability weighting function.
The value function has 3 important aspects:
Reference dependence (what you have now or what you expect
to have). Determines wheter we see something as a loss or a gain.
Loss aversion (we value losses more than gains).
Diminishing sensitivity. Value function is concave for gains and
convex for losses. It is best to separate gains and to integrate losses.
Endowment effect = once you have something, you value it more than when you didn’t have it.
When given a pen, you want more money for it if you were to sell it than if you were willing to pay to
buy it. This is because the disutility of losing the pen is greater that the utility of gaining the pen. This
is an example of loss aversion. Thus willingness to accept > willingness to pay. Works because of
reference dependence and loss aversion.
The status quo (you don’t want to lose what you have now) and the sunk cost also play a role in loss
aversion. Framing effect = people make different choices when they are written down differtently (asian
disease problem). Regret, frustration and self-satisfactory can influence framing, this won’t lead to
Probability weighting function = people distort probabilities. Moderate
probabilities are underestimated while small probabilities are overestimated. There
is utility based on weights. This leads to different results than loss aversion would
predict. This leads to violation of invariance.
small probability, gain risk seeking
small probability, loss risk aversion
moderate probability, gain risk aversion
moderate probability, loss risk seeking
Metacognitive effect = people do their best to not use heuristics, which will make them
Mental accounting = people organize the outcome of transactions in their head (makes differences
relative, why you would travel for 5,- discount on a 20,- shirt but not on an 80,- shirt).
Normative analysis = rationality and logic of human decision, how people should behave.
Descriptive analysis = the beliefs and preferences of people and how they actually behave.
Pseudo-certainty = when an effect that is uncertain is weighted as if it were certain.
Dead loss-effect = keep investing in something that will never be worth it Rational decisions should be governed by several principles:
transitivity (if A>B and B>C then A>C)
dominance (if A is at least as good in every aspect, but better in 1 aspect as B, A>B)
invariance (preference order should not depend on the manner in which they are described)
A change at the beginning or end of the scale has an bigger impact than the same change in the
middle of the scale. Experience value = the degree of pleasure/pain/satisfaction/anguish in the actual
experience of an outcome. Decision value = the contribution of an anticipated outcome to the overall
attractiveness or aversiveness of an option in a choice. This is a complicated relation since individuals
can’t perfectly predict the future. Module 3
There are 6 fundamental principles of persuasion:
reciprocity people repay in kind. People strive for equity/fairness/social justice.
o That’s not all technique = before one makes a decision, given them something (cost
reduction/extra product). Also works due to liking and favourable reference point.
o Door in the face technique = first ask for something big, most people reject, then ask
for a smaller favour. People tend to comply. Also works due to favourable reference
point and feelings of control.
Liking people tend to comply more with request from people they like. We like due to
physical attraction, compliments, similarity, familiarity (more exposure is better evaluations)
Social proof people follow the lead of similar others (Asch experiment, is line X the same
as line A/B/C?)
Commitment & consistency people align with their previous commitments. Works best
when the commitment is voluntary, large (big sunk cost), public and simplifies the decision
o Foot in the door technique = first ask for a small request, people tend to comply.
Then ask a large request, people say yes as well. Can backfire if the second questions
is to soon asked after the first.