Week 8: Decision Making in Organizational Contexts

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Questions and Answers

What are some key elements of effective decision making in organizational contexts? (Select all that apply)

Full vs bounded rationality (correct)

Common fallacies in reasoning (correct)

Satisficing perspective (correct)

Common biases in decision-making (correct)

Series of decisions

What is meant by 'satisficing' in decision making?

Satisficing refers to finding a solution that is satisfactory and sufficient, rather than seeking the optimal solution.

In prospect theory, people think of the outcomes of their decisions in terms of gains and gains only.

False

Decision makers in a boundedly-rational world often engage in _________________ rather than an optimizing problem.

satisficing Signup and view all the answers

Define availability bias.

Availability bias is a situation in which information that is more readily available is viewed as more likely to occur. Signup and view all the answers

What describes the inferences made about event commonness based on the ease of remembering instances of that event?

Availability heuristic Signup and view all the answers

Explain sampling bias.

Sampling bias is the tendency of individuals to make generalizations from a small number of sources rather than through large, randomly drawn samples that represent a wide audience. Signup and view all the answers

Hindsight bias refers to the increase in an individual's belief about their ability to predict an outcome after knowing the outcome.

True Signup and view all the answers

Escalation of commitment is the tendency to escalate commitment to a previously selected course of action beyond what is prescribed by ________ decision making.

rational Signup and view all the answers

What is the term used to describe the tendency to stick to the current state due to the perception that leaving it has larger disadvantages than advantages?

Status Quo Bias Signup and view all the answers

What does loss aversion imply about decision maker's risk behavior when choosing between gains and losses?

Risk seeking when choosing between losses Signup and view all the answers

Heuristics always lead to biased judgments.

False Signup and view all the answers

The idea of diminishing sensitivity is reflected in the shape of the value function, which is concave in the domain of __________ and convex in the domain of losses.

gains Signup and view all the answers

Match the following heuristics with their descriptions:

Availability Heuristic = Assesses the frequency of an event based on its memory availability Representativeness Heuristic = Judges individuals based on existing stereotypes Confirmation Heuristic = Testing hypotheses using selective data Signup and view all the answers

Study Notes

Decision Making in Organizational Contexts

The decision-making process is a critical aspect of organizational performance
Effective decision making improves organizational performance

Rational Decision Making

A six-step process:
1. Define the problem
2. Identify the criteria
3. Weigh the criteria
4. Generate alternatives
5. Rate each alternative on each criterion
6. Compute the optimal decision

Full Rationality

An "optimizing" process, where all possible alternatives are considered
Example: Consumer decisions, where multiple factors are weighed to make a decision

Bounded Rationality

Introduced by Herbert Simon
Individuals are boundedly rational, and their judgment is limited by:
1. Lack of information
2. Time and cost constraints
3. Limited memory and intelligence
4. Difficulty in accurately calculating the optimal choice

Satisficing

A decision-making approach that seeks a "good enough" solution rather than an optimal one
Involves searching until a satisfactory solution is found that meets an acceptable level of performance
Test yourself: Are you a maximizer or a satisficer?

Prospect Theory

Introduced by Daniel Kahneman and Amos Tversky
People think in terms of gains and losses, rather than absolute values
Three main features:
1. Reference Point: The idea that value is relative and requires a reference point
2. Loss Aversion: The tendency to prefer avoiding losses to acquiring gains
3. Diminishing Sensitivity: The idea that the value of a gain or loss decreases as the magnitude increases

Biases and Heuristics

Judgement heuristics:
- The Availability Heuristic: Judging frequency or probability by how easily instances come to mind
- The Representativeness Heuristic: Judging individuals based on stereotypes

Nudges

Small changes in the environment that can influence people's behavior in a predictable way
Non-intrusive, leveraging System 1 thinking, and making the desired behavior easier and more accessible### Heuristics and Biases
The Representativeness Heuristic: predicting a person's performance based on an established category of people they represent.
The Confirmation Heuristic (or "positive hypothesis testing"): selectively seeking data that confirms a hypothesis, neglecting other possibilities.
The Affect Heuristic: making judgments based on emotional evaluations, rather than thorough analysis.

Heuristics: Good or Bad?

Heuristics are efficient ways to make decisions, but can lead to biased judgments when inappropriately applied.
Examples of heuristics include the Availability Heuristic, Representativeness Heuristic, and Confirmation Heuristic.

From Heuristics to Biases

Availability Heuristic: overestimating the importance of vivid or memorable information.
Representativeness Heuristic: judging likelihood based on superficial similarity rather than statistical probability.
Confirmation Heuristic: selectively seeking data that confirms a hypothesis, neglecting other possibilities.

Case Study: Marla's Strategy

Marla's strategy of limiting her search to new MBAs from the top six European management schools may lead to biased judgments.

Biases

Availability bias: judging likelihood based on how easily examples come to mind.
Sampling bias: generalizing from small, unrepresentative samples.
Anchoring and Adjustment bias: relying too heavily on arbitrary numbers or facts when making decisions.
Hindsight bias: believing, after an event, that it was predictable, and that we would have predicted it.

Case Study: Death Causes

Ranking the causes of death in the United States in 2020: cancer, domestic accidents, COVID-19, diabetes, and firearms.

Easy of Recall Bias

Situation: information that is more readily available is viewed as more likely to occur.
Why: we tend to recall vivid or memorable information more easily.
Where: partner selection, performance appraisals, and decision-making in general.

Sampling Bias

Tendency to make generalizations from small, unrepresentative samples.
Why: sample size is rarely considered in our intuition.
Where: advertising campaigns ("4 out of 5 dentists recommend...").

Anchoring and Adjustment Bias

Relying too heavily on arbitrary numbers or facts when making decisions.
Why: we often develop estimates by starting with an initial anchor and adjusting from there.
Where: real estate market, labor market, and any market with high information asymmetries.

Hindsight Bias

Believing, after an event, that it was predictable, and that we would have predicted it.
Why: knowledge of an event's outcome works as an anchor, making us overestimate our prior judgments of the event's likelihood.
Where: performance appraisals, evaluating employee performance, and decision-making in general.

Series of Decisions

Many critical managerial decisions involve a series of choices rather than a single decision.
Escalation of commitment: a tendency to escalate commitment to an initial decision, often beyond rationality.

Escalation of Commitment

Decisions have to be made as results of other decisions.
Non-rational escalation: committing to a course of action beyond the point prescribed by rational decision-making.
Where: investment decisions, hiring and promoting decisions, betting decisions, and life-choices decisions.

Solutions to Escalation of Commitment

Focus on future costs and benefits, ignoring previous commitments (treat previous commitments as sunk costs).
Encourage good decision-making practices, rather than impression management.

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Description

Learn about the decision-making process in organizations, including full vs bounded rationality, satisficing, common fallacies, biases, and series of decisions.