70-386 Behavioral Decision Making

1. 70-386 Behavioral Decision Making Lecture 1: Introduction

2. What is Behavioral Decision Research? • What is an optimal decision? • Normative: Decision Analysis / Economics • What do we need to understand in order to make good decisions? • Quality of information. • How do people actually make decisions? • Descriptive: Psychology • Limits on the quality of information or limits on the quality of decision making capabilities. • How can people be helped to make better decisions (by overcoming these biases)? • Prescriptive: Public Policy • Risk communication or limit choices

3. Some things you might learn in this course • Why adding a product nobody buys may be beneficial to the seller • Why you can’t find a cab on a rainy day • Why people might donate more to save one person rather than 1000s • Why someone might be risk-adverse sometimes and risk-seeking sometimes – even when facing the same choice • A reason why too many people start businesses that fail.

4. Course Overview

5. Course Logistics • This is a mini course. • Fast pace: a lot of material per meeting • almost a chapter per class and classes meet 3x a week. • Attendance and Participation • Required. Participation is not just coming to class. • Phones / computers • If you’d rather check FB/twitter/instagram/etcthan pay attention, don’t come to class. • Office hours: • Will let you know by next time, but with an open door policy. • Outside of set office hours, set up an appointment.

6. Course Grades Course grades will be based on: • Participation 10% • Midterm exam 20% • Three weeks from today! • Final exam 20% • Quizzes 30% (10% each, best 3 of 4) • First quiz next Sunday • Group paper presentation: 20%

7. Course Schedule • See the last page of the syllabus for a tentative schedule • Readings after week two aren’t list; they will be. • There is a natural progression of material in Economics/Decision Analysis. Less so in BDR • BDR is a much younger field. A coherent theory for everything we’ll discuss still isn’t exactly worked out. • Doesn’t mean that it’s wrong – just that we’re still trying to figure things out.

8. Teaching this course. First time I’ve taught this course • There will be changes throughout the course. Usually it takes about 3 times before I think a course is about right. Sorry, but you have to start somewhere. • But we’ll work together. The material is interesting. And the course is meant to give you an overview of a field you probably haven’t seen. I love my job. I want to teach the best that I can. But to do that I need to get to know you • Stop by my office this week for 5-10 min, even if you’ve had me before.

9. Recommended books • We’ll draw on these later in the course, but if you find the material interesting, definitely check out (in the library): • Nudge, by Thaler and Sunstein • Thinking Fast and Slow, by Kahneman • Predictably Irrational, by Ariely

10. Decision Making Review

11. What is a decision?

12. Decision Evaluation • I bought a lottery ticket and won $10,000 • Was buying the ticket a good decision? Why or Why Not? • Ex post or ex ante? • How do you measure the quality of a decision? • Outcome Quality • Decision Process Quality

13. Optimal decision analysis • Define the problem • Do NOT define in terms of a proposed sol’nor diagnosed symptoms. • Identify the criteria • What’s the objective? Is there more than one? • Weigh the criteria • What matters? Some things matter more than others • Generate alternatives • What are the courses of action available? • Rate each alternative on each criterion • What are the payoffs? • Is there any uncertainty? Do you need to forecast future events? • Compute the optimal decision • What is your utility function? What is your tolerance for risk?

14. Evaluating the Process • The soundness of the decision-making process determines the quality of the decision, not the attractiveness of the outcome. • Making the optimal decision is tough. • Satisficing: making a choice that is “good enough” rather than optimizing to find the ideal choice (Herb Simon 1956). Example: choosing a college or university. • Heuristics: Decision aids or “shortcuts” that we rely on to make complex decisions manageable. • What might affect our decision-making processes • Reliance on heuristics often leads to biases --- deviations from normatively sound perceptions and judgments. • Optical Illusions as an Analogy: The image we see may lead us to a mistaken or biased representation of reality

15. How many of the discs are spinning?

16. Cognitive Illusions • Cognitive illusions are similar to optical illusions in that they, too, can cause us to misperceive the world • Biases emerge in: • Drawing comparisons • Evaluating probabilities • Reasoning from the past • Extrapolating from limited data • Assessing our own values • .....

17. Difference are not always mistakes • Two equally valid interpretations of the same data. • Can we justify differences? • Subjective probability: different interpretations of same set of evidence • (Leonard Savage 1954) • Personally value outcomes differently • Risk Judgments (e.g. cars vs. airplanes) • Value Elicitation (e.g. Fischhoff 1991) • Normative and descriptive analysis are interdependent!

18. Results from Psychology vs Economics Economics : Homo economicus Psychology Irrational Decision Makers (“humans”) • Stable, complete and transitive preferences • Utility maximizers • `Perfect’ foresight Normative • Unstable preferences • Context matters • Satisficing + systematic “errors” Descriptive

19. Questionnaire

20. Next time – by 26/8/14 • Read Chapter 2 in JMDM • Meet with me this week