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Standard models of decision-making hold that rational agents maximize expected utility. These models presuppose a notion of rationality that is substantive (i.e., that involves making choices that have certain substantive outcomes, such as maximizing expected utility) and forwardlooking (i.e., that is solely a function of future costs and benefits). Despite the fact that this notion of “utility” is notoriously vague, utility maximization theories have a formal clarity and precision. Unfortunately, they also make highly idealized assumptions about decision-makers—namely that they are superhuman probability calculators whose preferences are precisely and stably ordered.
Since the 1950s, economists and psychologists have moved away from forward-looking, substantive theories of rationality, and toward procedural theories of rationality. Procedural theories take rationality to involve making choices in accordance with certain rules or processes, and these rules or processes are typically grounded in psychologically realistic accounts of decision-making. This focus has led to an explosion of research into decision-making in business, government, and the marketplace. Much of the groundbreaking work in this area was done by Amos Tversky and Daniel Kahneman (Kahneman won the Nobel Prize for Economics in 2002 for his research on the economics of choice).
Automatic vs. Deliberative Processes
While the paradigm case of decision-making is voluntary and deliberative (e.g., selecting a new car or a retirement plan), many cognitive processes are involuntary and automatic. Some automatic decision-making seems to occur in a perception-like system. These “System 1” processes are fast, automatic, parallel, effortless, associative, and emotional. “System 2” processes, on the other hand, are slow (in the deliberative sense), serial, controlled, effortful, rule-governed, flexible and emotionally neutral. Reasoning is a characteristic System 2 process. Which system is being used can be determined by an effort diagnostic: System 2 processes are easily interfered with by a simultaneous activity.
System 1 processes include impression formation, one-on-one communication, and much group behavior. John Bargh’s work shows that much of our social behavior (e.g., nose-scratching) is imitative, triggered automatically by an activation of the motor cortex. Consumer choice, memory for events, mathematical skills, and hostility for others are regulated by automatic processes that people are largely unaware of, and which can be triggered by environmental features to which people pay no explicit attention. For example, music in a store can reduce the shopper’s blink rate from the normal average of thirty-two times a minute to a hypnotic (and suggestible) fourteen blinks a minute (Smith and Curnow 1966).
Framing effects occur when messages carrying the same statistical information cast in different ways prompt different behavior. If someone who tests positive for HIV or breast cancer has a 70 percent chance of living beyond seven years, then that person has a 30 percent chance of dying within seven years. But these messages have different impacts. In 2001, Tamera Schneider and colleagues created gain-framed videos that explained the positive effects of healthful behavior and regular breast exams, as well as loss-framed videos that attempted to frighten viewers with the potential negative consequences of not seeing a doctor. Subjects in the gain-framed message condition were significantly more likely to arrange mammograms. In a 2003 paper, Anne Marie Apanovitch, Danielle McCarthy, and Peter Salovey showed that message framing also motivates subjects to get tested for HIV.
The Fundamental Attribution Error
When observing the behavior of others, people tend to overattribute behavior to dispositional factors, such as motives, capacities, and personality traits. They also tend to underestimate the causal influence of situational factors, such as whether the subject is pressed for time or is in an uncomfortably warm room. This “fundamental attribution error” (FAE) has proved both stable and resistant to correction. Interestingly, however, Incheol Choi and Richard Nisbett found in 1998 that Koreans are significantly less susceptible to the FAE than Americans.
The FAE leads to the actor-observer effect, where people tend to explain their own behavior in terms of situational factors, while other people’s behavior is explained in terms of dispositional factors. A noteworthy consequence of the actor-observer effect is that people tend to explain other people’s economic successes or difficulties in terms of behavioral and dispositional factors. They tend to explain wealth in terms of hard work and wise decisions, but rather than explain poverty in terms of the situations of those suffering, it is often explained with derogatory attributions. In other words, it is often believed that people are poor because they are lazy, stupid or ignorant. Situational factors are, however, thought to exert a potent influence on social behavior.
A number of studies that allow subjects to predict how some event will affect their life or the lives of others have confirmed that people are not good at tracking the impact and duration that events will have on our lives. There is a wide gulf between what people believe makes them happy and what actually does make them happy. Events that are predicted to be devastating, such as getting denied tenure, and those thought to make one happy, such as gaining tenure or winning the lottery, often have no lasting impact on human happiness (see Gilbert, et al. 1998; Brickman et al. 1978). It may be difficult for people to admit, but affective forecasting—the psychological process of predicting how one will react to life events—cannot be trusted (see Wilson and Gilbert 2003). As Kahneman et al. put it, “People are unable to produce an accurate and unbiased evaluation of experiences that extend over time” (2004, p. 430). When it comes to what makes one happy, people have a mixture of true beliefs (having a satisfying occupation; having a number of caring, emotionally intimate relationships; sound health; or the feeling of security from personal threat) and false beliefs (having more money [if they are middle class or above], a fast car, or a vacation home).
Discounting the Future
People tend to discount the future. If given a choice between taking ten dollars now or in ten years, it is undoubtedly more rational to take the money now. Certainly inflation will make it less valuable in ten years, and the future is uncertain. But the problem is that people tend to discount the future far too steeply. This is evident in the very low contribution rates many people make to their retirement plans. People take their money now, even when the payoff at retirement is high and the probability of an interfering event is low. In so doing, people end up making choices that are inconsistent with their life plans.
But perhaps the impulse for immediate satisfaction should be forgiven. When people lying in a magnetic resonance imaging (MRI) machine are asked to choose between two options—an item now and a more valuable one in the future—the prefrontal cortex busily calculates the various payoffs over time, lighting up the image with blood flow activity (McClure et al. 2004). But when a person chooses the present pleasure, the limbic system—which governs the emotions and spontaneous responses—also flashes brilliantly. Thus, people are biologically programmed to respond more strongly to present pleasures, and while they might find it difficult to eliminate their biases, some biases can be used to cancel out others. Richard Thaler and Shlomo Benartzi’s Save More Tomorrow Plan (SMT) is a fine example of this sort of psychological ju jitsu.
SMT uses one set of biases (the tendency toward decision-making inertia and procrastination) to counteract another bias (the failure to properly discount the future). The plan application asks prospective participants if they would like to start saving three months from now, and it commits them to doing so at the time of enrollment. The time lag allows people to experience whatever they find attractive about procrastination, but once enrolled in the plan, inertia takes over and people tend not to opt out. Thaler and Benartzi also curb a powerful psychological factor—loss aversion—that would lead people to decline to participate in the plan. People tend to weigh losses far more heavily than gains, and so tend to work hard to avoid sure losses. Loss aversion tends to prevent people from enrolling in a program in which they will witness a decrease in their paycheck. So SMT takes the increased contribution out of the employee’s pay raise, so that it is not experienced as a loss. For those involved in this plan, saving rates more than tripled, from 3.5 percent to 11.6 percent, over 28 months.
Contemporary research into decision-making focuses on describing the processes employed by decision-makers. By discovering processes that consistently lead to decisions that are in some sense non-optimal, researchers can offer psychologically tractable proposals for improving decision-making. This research has produced, and will continue to produce, important practical and theoretical results for economics, organizational behavior, investment performance, organ donation planning, insurance, traffic theory, criminal corrections, medical diagnosis, and many other areas that are significant to people’s lives.
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