Availability Heuristic Quiz: Understanding Cognitive Bias

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Questions and Answers

What is the Availability Heuristic?

It is the act of passing a quick judgment on a circumstance based on recalling past events.

Give an example of the Availability Heuristic.

Someone hesitant to invest money because they anticipate losing it again.

Explain Anchoring and Adjustment.

It occurs when a person heavily relies on initial financial information received.

How does the Availability Heuristic influence decision-making?

It influences decision-making by shaping judgments based on easily recalled past events. Signup and view all the answers

Why is the Availability Heuristic considered a mental shortcut?

It is considered a mental shortcut because it allows for quick judgments based on memory instead of thorough analysis. Signup and view all the answers

How can individuals use the Availability Heuristic in making investment decisions?

They can look into historical performance of assets to guide their investment choices. Signup and view all the answers

What is a heuristic also known as?

Rule of Thumb Signup and view all the answers

Give an example of using a heuristic in a dark alley scenario.

When you see a person with their hood up in a dark alley and decide to walk past faster. Signup and view all the answers

Who developed the Prospect Theory?

Amos Tversky and Daniel Kahneman Signup and view all the answers

What advantage does a heuristic offer in decision-making?

Delivers an immediate result Signup and view all the answers

What disadvantage is associated with using heuristics in investments?

Can lead to miscalculation of investments Signup and view all the answers

Who questioned why people, companies, and business firms do not act in a rational way?

Herbert Simon Signup and view all the answers

What is the phenomenon where an individual bases their initial ideas and responses on one point of information and makes changes driven by that starting point?

Anchoring and adjustment Signup and view all the answers

Give an example of how anchoring and adjustment can influence negotiations.

A used car salesman offering a very high price to start negotiations. Signup and view all the answers

What is representativeness in investment decision-making?

Representativeness heuristic Signup and view all the answers

How does the representativeness heuristic influence investors' decisions?

Investors tend to believe that a history of remarkable performance will continue in the future. Signup and view all the answers

Explain how representativeness can affect investors' perceptions of a firm's future performance.

Investors believe a firm's remarkable past performance will continue in the future. Signup and view all the answers

What impact does representativeness have on investment decision-making under uncertainty?

Investors tend to believe a remarkable past performance is representative of future performance. Signup and view all the answers

Study Notes

Biases and Heuristics in Decision-Making

Availability Heuristic: a mental shortcut where individuals judge the likelihood of an event based on how easily examples come to mind, rather than on the actual probability of the event.

Example of Availability Heuristic

Overestimating the prevalence of plane crashes due to media coverage, leading to an irrational fear of flying.

Anchoring and Adjustment

A cognitive bias where an individual relies too heavily on the first piece of information they receive (anchor) and makes adjustments to it, rather than considering a wide range of possibilities.
Leads to irrational decisions as the anchor influences the outcome, often resulting in a less accurate assessment.

Influence of Availability Heuristic on Decision-Making

Leads to biased decisions based on vivid or recent events, rather than objective probability.
Can result in overestimating or underestimating risks, leading to poor investment decisions.

Why Availability Heuristic is a Mental Shortcut

It's a quick and easy way to make decisions, rather than taking the time to consider all relevant information.
However, it can lead to inaccurate judgments and suboptimal decisions.

Using Availability Heuristic in Investment Decisions

Can be used to identify potential risks or opportunities based on recent events or trends.
However, it's essential to balance this with more objective analysis to avoid biases.

Heuristics

Also known as mental rules of thumb or shortcuts.
Allow individuals to make quick and efficient decisions, but can lead to biases and errors.

Example of Using a Heuristic in a Dark Alley Scenario

Assuming a situation is more dangerous than it is due to a vivid memory of a similar past event.

Prospect Theory

Developed by Daniel Kahneman and Amos Tversky to explain how people make decisions under uncertainty.
Suggests that people tend to be risk-averse when considering gains, but risk-seeking when considering losses.

Advantages and Disadvantages of Heuristics

Advantages: quick and efficient decision-making, reduced mental effort.
Disadvantages: can lead to biases and errors, particularly in investment decisions.

Questioning Rationality

Daniel Kahneman and Amos Tversky questioned why people, companies, and business firms do not act in a rational way, leading to the development of Prospect Theory.

Anchoring and Adjustment in Decision-Making

Phenomenon where an individual bases their initial ideas and responses on one point of information and makes changes driven by that starting point.
Leads to biased decisions and can affect negotiations.

Anchoring and Adjustment in Negotiations

Example: a seller sets a high initial price, anchoring the buyer's expectations, leading to a lower perceived value.

Representativeness in Investment Decision-Making

A heuristic where individuals judge the likelihood of an event based on how closely it resembles a typical case, rather than on the actual probability of the event.
Leads to irrational decisions based on stereotypes or superficial characteristics.

Influence of Representativeness on Investors' Decisions

Causes investors to overreact to news or events that are similar to past experiences, rather than considering the actual probability of the event.
Can result in overestimating or underestimating risks, leading to poor investment decisions.

Representativeness and Uncertainty

Can lead to an overestimation of the likelihood of a event due to a vivid or recent example, rather than considering the actual probability.
Can result in poor investment decisions under uncertainty.

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Description

Test your knowledge on the availability heuristic, a cognitive bias where people rely on their memory of past events to make judgments about the likelihood of an event. This quiz covers the characteristics and examples of availability heuristic.

Types of Heuristic: Availability Heuristic Quiz

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