Forman@gwu ProfessorForman

1. Executive Decision Making/ Collaborative Decision Making Not Everything That Counts Can Be Counted (Measured)andNot Everything That Can Be Counted (Measured), Counts Albert Einstein Forman@gwu.edu http://ProfessorForman.com

2. Session 1 • Introduction to decision making concepts, theory and practice. • Intuition (Emotion) and Reason (Rationality) • Intuitive irrationalities • Cognitive limitations and bounded rationality

3. Executive/Collaborative Decision Making • Prioritize for making decisions • Choice • Selecting the ‘best’ alternative • Resource Allocation • Selecting the ‘best’ combination of alternatives • Justify/defend recommendations • Improve communications • Achieve consensus • Make meetings more effective • Deliver powerful presentations

4. Need for Better Decision Making • Executives rate decision-making ability as the most important business skill, but few people have the training they need to make good decisions consistently. • from Russo and Schoemaker -- Decision Traps • Becoming a good decision maker requires coaching just like becoming a good athlete

5. Everyone is an ‘expert’ Our marketing study indicates that we should locate in the China Our financial analysis indicates that we should locate in the Far East Considering production and operations, we should locate in Mexico Public Policy considerations point to locating in the U.S.

6. What is the challenge decision- makers have today? • Complexity • Competing Objectives • Tradeoffs • Cognitive Limitations • Data Overload • Multiple Perspectives • Constraints • Uncertainty and Risk

7. Limitations of methods in use today • BOGSAT (Bunch of Old Guys/Gals Sitting Around Talking) • Intuitive biases and irrationalities • Cognitive limitations • Satisficing • Common simplistic strategies • Inadequate measurement meaning (Levels of measurement) • Nonlinear utilities

8. How do we make decisions? • Intuition and Reason • Emotion and Reason • Unconscious and Conscious • System 1 and System 2 (Fast and Slow) • Id and Ego • Amygdala and Prefrontal Cortex

9. Intuition/EmotionReason/Rationality • Intuition/Emotion Vs.& Reason • Plato… • Classical (Standard) Economics • Behavioral Economists • Brain research • Pathology • fMRI • How We Decide (Lehrer)* (Withdrawn from market) • Thinking, Fast and Slow (Kahneman) • System 1 and System 2 Thinking • Predictably Irrational (Ariely) • Misbehaving (Thaler)

10. Rationality/Reason • Prefrontal Cortex • https://www.thescienceofpsychotherapy.com/prefrontal-cortex/ • https://www.thescienceofpsychotherapy.com/glossary/amygdala/

11. Intuition/Emotion • Vast majority of decisions (BOGGSAT) • Amygdala • Unconscious • Very Powerful • Constantly learning • Thinking Fast – or not even thinking • Conflicting signals • Flaws • Prone to biases and errors • Flaws (irrationalities) are predictable • Questionable under new circumstances • Difficult to synthesize different individuals intuitions

12. Intuition/Emotion • Behavioral Economics • Very interesting to study • We will look at some first week • But that won’t be the focus of the course • Our intuitions, while quite powerful • often don’t conform to what economists or economists would say is ‘rational’ • can be misleading or ‘biased’ • Intuition about best alternative • Not reliable for important decisions • Will see why next • Intuition/Emotion for specific parts of a decision • Emotions will be a big part of our rational decision-making approach • Preferences for alternatives with respect to objectives • Importance of objectives

13. If we could wrap a wire around the earth… • If the earth were a perfect sphere, and we wrapped a wire tightly around the equator, approximately how long would the wire be? • about 25,000 miles • If we cut the wire, spliced in another 12 feet (not miles) and distributed the slack evenly around the earth, would there be enough slack for a mouse to crawl under the wire?

14. Intuition sometimes fails • 2 ∏ r = 25,000 miles • 2 ∏ (r + ∆r) = 25,000 miles + 12 feet • Subtract first line from second • 2 ∏∆r = 12 feet • or ∆r is almost 2 feet! (all the way around the earth)

15. Behavioral EconomicsTwo kinds of theories • The organizing principle of Behavioral Economics was the existence of two different kinds of theories • Normative (Prescriptive) • Normative theories tell you the right way to think about some problem. • logically consistent, as prescribed by the optimizing model at the heart of economic reasoning, • sometimes called rational choice theory. • For instance, the Pythagorean theorem is a normative theory of how to calculate the length of one side of a right triangle if you know the length of the other two sides. If you use any other formula you will be wrong. • Descriptive • Describes how people actually think and choose/decide Thaler, Richard H. (2015-05-11). Misbehaving: The Making of Behavioral Economics (Kindle Locations 495-500). W. W. Norton & Company. Kindle Edition.

16. Here is a test to see if you are a good intuitive Pythagorean thinker. • Consider two pieces of railroad track, each one mile long, laid end to end • The tracks are nailed down at their end points but simply meet in the middle. • Now, suppose it gets hot and the railroad tracks expand, each by one inch. • Since they are attached to the ground at the end points, the tracks can only expand by rising like a drawbridge. Furthermore, these pieces of track are so sturdy that they retain their straight, linear shape as they go up. • Thaler, Richard H. (2015-05-11). Misbehaving: The Making of Behavioral Economics (Kindle Locations 501-505). W. W. Norton & Company. Kindle Edition.

17. Train Track Segments by how much does the track rise above the ground? Thaler, Richard H. (2015-05-11). Misbehaving: The Making of Behavioral Economics (Kindle Locations 506-507). W. W. Norton & Company. Kindle Edition. With Excel

18. Intuition again? • http://www.shodor.org/interactivate/activities/SimpleMontyHall/

19. More Illusions and Biases • Visual Illusions • Cognitive Illusions

20. Illusions • Visual Illusions • Illusions as a Metaphor “Decision Illusions”

21. More visual illusions • Some from www.ilusaodeotica.com

22. Illusions -- relativity • The middle circle is the same size in both positions • but it appears to change depending on what we place next to it. • This might be a mere curiosity, but for the fact that it mirrors the way the mind is wired • we are always looking at the things around us in relation to others • We can’t help it. • This holds true not only for physical things • —toasters, bicycles, puppies, restaurant entrées, and spouses— • but for experiences • such as vacations and educational options, • and for ephemeral things as well: • emotions, attitudes, and points of view. Ariely, Dan (2009-06-06). Predictably Irrational, The Hidden Forces That Shape Our Decisions (p. 7).

23. Relativity • RELATIVITY IS (RELATIVELY) easy to understand. • But there’s one aspect of relativity that consistently trips us up. It’s this: • we not only tend to compare things with one another • but also tend to focus on comparing things that are easily comparable (thinking fast) • and avoid comparing things that cannot be compared easily (thinking slow)

24. Subscriptions to Economist • The ‘dominated’ or decoy option makes it easier for us to compare and we avoid thinking hard about the real tradeoffs

25. Cognitive/Decision Making IllusionsDan Ariely’s Video • Organ Donations • Trip to Paris or Rome • Doctors and Hip Replacement • Forgot ibprofen • Forgot ibprofen or piroxicam • Attractiveness of faces • We don’t know our own preferences very well

26. TAPPS • Thinking aloud paired problem solving… • Behavioral Economics • Kahneman and Tversky • Spend 5 - 10 minutes to find out what you can about • Behavioral Economics • Kahneman and Tversky • Prospect Theory • Post a reply to this thread with what you think might be the most useful and include links (URL's) to information that you find. • Podcast interview with Kahnerman Aug 2016

27. Prospect Theory Concave: Diminishing returns • Risk Averse • From any point on the curve the prospect of a 50/50 gamble to win x or lose x doesn’t pay • Why? • Because the change on the y axis for gains is smaller than the change on the y axis for losing All value (utility) is subjective!

28. Prospect Theory But for losses, they found: 1) Curve is steeper Losses are more important to people than gains Survival of the fittest One criticism of your spouse requires at least 2 or 3 praises 2) Curve is convex People avoid risks when it comes to gains Curve was convex People are risk seeking for losses Framing Of course, what is positive and what is negative depends on your frame of reference and how the questions are posed…. More later

29. Loss aversion • ... when a person was offered a gamble on the toss of a coin • and was told that losing would cost twenty dollars • the player demanded, on average, around forty dollars for winning • The pain of a loss was approximately twice as potent as the pleasure generated by a gain

30. Kahneman and Tversky: • "In human decision making losses loom larger than gains." • Loss aversion is an innate flaw • Everyone who experiences emotion is vulnerable to its effects • It's part of a larger psychological phenomenon known as negativity bias • which means that, for the human mind, bad is stronger than good.

31. This is why in marital interactions, it generally takes at least five kind comments to compensate for one critical comment • Loss aversion is now recognized as a powerful mental habit with widespread implications. • The desire to avoid anything that smacks of loss often shapes our behavior, leading us to do foolish things

32. Economics(rational economics) Know all information Cognitive Ability to Evaluate options Tradeoffs among options Examples: Decision Trees Linear Programming Coefficients of Objective Function Behavioral Economics study the effects of psychological, social, cognitive, and emotional factors on the economicdecisions of individuals and institutions The problem with economics is that it is designed for the perfectly rational, perfectly informed person possessed of infinite calculating ability. AKA An ECONOMIC It isn't designed for the HUMAN brain as it has currently evolved. By assuming a world of perfect information ….. … ability to maximize expected utility in a series of stand alone transactions, …. there would be no advertising agencies. Because if everyone knew what they want and … then you don't need a marketing firm. The fact is that those conditions exist in the real world somewhere between very very rarely and never. Rory Sutherland“The Maddest Men of All”

33. Bayes Rule • … and base rates • Wikipedia Base Rates • Imagine that there is a type of cancer that afflicts 1% of all people • A doctor then says there is a test for that cancer which is about 80% reliable • He also says that the test provides a positive result for 100% of people who have the cancer, • but it is also results in a 'false positive' for 20% of people - who actually do not have the cancer. • Now, if we test positive, we may be tempted to think it is 80% likely that we have the cancer. • in fact, our odds are less than 5%.

34. Ariely -- Predictably Irrational • Standard Economics Assumes Rationality • 1) That we know all relevant information • 2) that we can compute the utility of each option, and • 3) we are cognitively capable weighing the ramifications of each potential choice

35. The result is that we are presumed to be making logical and sensible decisions. • And even if we make a wrong decision from time to time, the standard economics perspective suggests that we will quickly learn from our mistakes either on our own or with the help of “market forces.” • On the basis of these assumptions, economists draw far-reaching conclusions about everything from shopping trends to law to public policy.

36. But, as the results presented in this book (and others) show, we are all far less rational in our decision making than standard economic theory assumes. • Our irrational behaviors are neither random nor senseless— • they are systematic and predictable. • We all make the same types of mistakes • over and over, because of the basic wiring of our brains.

37. But there is a silver lining • the fact that we make mistakes also means that • there are ways to improve our decisions— • and therefore that there are opportunities for “free lunches.”

38. What is a ‘free lunch’ in this context? • According to the assumptions of standard economics, • all human decisions are rational and informed, motivated by an accurate concept of the worth of all goods and services and the amount of happiness (utility) all decisions are likely to produce. • Under this set of assumptions, everyone in the marketplace is trying to maximize profit and striving to optimize his experiences. • As a consequence, economic theory asserts that there are no free lunches—if there were any, someone would have already found them and extracted all their value.

39. Behavioral economists… • believe that people are susceptible to irrelevant influences from their immediate environment (which we call context effects), • irrelevant emotions, • shortsightedness, and • other forms of irrationality • …. Loss aversion; anchoring;…

40. The good news is that these mistakes also provide opportunities for improvement • If we all make systematic mistakes in our decisions, then • why not develop new • strategies, • tools, and • methods • to help us make better decisions and improve our overall well-being?

41. That’s exactly the meaning of free lunches from the perspective of behavioral economics • —the idea that there are tools, methods, and policies that can help all of us make better decisions and as a consequence achieve what we desire • And that is what we will be doing in this course!

42. Each of the chapters in this (Aerelli’s) book describes a force (emotions, relativity, social norms, etc.) that influences our behavior. • our natural tendency is to vastly underestimate or completely ignore this power. • These influences have an effect on us not because we lack knowledge, lack practice, or are weak-minded. • On the contrary, they repeatedly affect experts as well as novices in systematic and predictable ways.

43. Just as we can’t help being fooled by visual illusions, we fall for the “decision illusions” our minds show us. • our visual and decision environments are filtered to us courtesy of our eyes, our ears, our senses of smell and touch, and • the master of it all, our brain. • By the time we comprehend and digest information, it is not necessarily a true reflection of reality.

44. In essence, we are limited to the tools nature has given us, and the natural way in which we make decisions is limited by the quality and accuracy of these tools. • although irrationality is commonplace, it does not necessarily mean that we are helpless • we can • try to be more vigilant, force ourselves to think differently about these decisions, or • use technology to overcome our inherent shortcomings *** ***Technology meaning techniques, including processes, mathematics, software, …

46. 58 cognitive biases that screw up everything we do • https://www.businessinsider.com/cognitive-biases-2015-10 • Skip to slide 66 • May return here if time permits • Otherwise read at home

47. Decision Traps • In their original book, Decision Traps, Russo and Shoemaker focus on 10 decision traps • These traps are based on some ‘defects’ in human emotional/intuitive responses…

48. Decision Traps • Most Decision-Makers Commit the Same Kinds of Errors • Decision research has shown that people in numerous fields tend to make the same kinds of decision-making mistakes. • Here is a summary of the ten most dangerous decision traps:

49. 1. Plunging In—Beginning to gather information and reach conclusions without first taking a few minutes to think about the crux of the issue you’re facing or to think through how you believe decisions like this one should be made. • 2. Frame Blindness—Setting out to solve the wrong problem because you have created a mental framework for your decision, with little thought, that causes you to overlook the best options or lose sight of important objectives. • 3. Lack of Frame control—Failing to consciously define the problem in more ways than one or being unduly influenced by the frames of others.

50. 4. Overconfidence in Your Judgment—Failing to collect key factual information because you are too sure of your assumptions and opinions. • 5. Shortsighted Shortcuts—Relying inappropriately on “rules of thumb” such as implicitly trusting the most readily available information or anchoring too much on convenient facts. • 6. Shooting From the hip—Believing you can keep straight in your head all the information you’ve discovered, and therefore “winging it” rather than following a systematic procedure when making the final choice.