Overview
This lecture examines the systematic biases in human judgment and decision making, describes major types of bias, and shares practical strategies to improve decision outcomes.
Bounded Rationality in Decision Making
- People aim to make rational choices but are limited by cognitive constraints, incomplete information, and memory limits (bounded rationality).
- Nobel-winning research by Simon, Tversky, and Kahneman identified predictable patterns of judgment errors.
The Rational Decision-Making Model
- Rational decision making involves: defining the problem, identifying and weighing criteria, generating alternatives, rating options, and computing the optimal choice.
- Most people do not systematically follow these steps, often relying too much on intuition.
Common Biases in Judgment
- Heuristics are mental shortcuts that simplify decisions but often lead to predictable errors.
- Overconfidence bias: people overestimate the accuracy of their judgments.
- Anchoring bias: initial values influence subsequent estimates, even if arbitrary.
- Framing bias: people react differently depending on how choices are presented (gains vs. losses).
Other Systematic Biases
- People favor easily retrievable information and often ignore statistical base rates.
- Confirmation bias leads individuals to seek information supporting existing beliefs.
- Hindsight bias causes people to overestimate their ability to predict outcomes after events occur.
Extensions to Bounded Rationality
- Bounded willpower: people often prioritize short-term over long-term benefits.
- Bounded self-interest: people care about others' outcomes, both positively and negatively.
- Bounded ethicality: ethical limits influence decisions unconsciously.
- Bounded awareness: failure to notice obvious information affects judgment.
Improving Decision Making (“Fixing Our Decisions”)
- System 1 (fast, intuitive) and System 2 (slow, logical) thinking describe dual-process decision making.
- Important decisions benefit from deliberate (System 2) reasoning rather than relying on intuition.
- Environmental “nudges” (e.g., setting beneficial defaults) help people make better choices, as seen in retirement savings and organ donor policies.
Conclusions
- Understanding decision biases allows individuals to mitigate poor judgment and make better choices.
- Modern research is being applied in economics, finance, and policy design to improve decision outcomes.
Key Terms & Definitions
- Anchoring — Reacting to initial numbers or values, insufficiently adjusting from them.
- Biases — Systematic, predictable mistakes affecting judgment.
- Bounded rationality — Limits on rational decision making due to cognitive constraints.
- Heuristics — Mental shortcuts for decision making.
- Overconfidence — Having too much confidence in one's judgments.
- Framing — Effect of information presentation on decisions.
- Bounded willpower — Tendency to prioritize present over future gains.
- Bounded self-interest — Caring about others' outcomes systematically.
- Bounded ethicality — Limits in ethical awareness affecting decisions.
- Bounded awareness — Missing obvious, important information.
- System 1 — Fast, intuitive, automatic thinking.
- System 2 — Slow, deliberate, logical thinking.
Action Items / Next Steps
- Reflect on your own decision-making processes for evidence of bias.
- Practice applying the six-step rational decision-making model to important choices.
- Read further on “Nudge” by Thaler & Sunstein for examples of behavioral design.