Lecture 1: Cognition & Decision-Making PDF

Cognition After this session you will be able to understand how people make economic judgements identify heuristics spot the use of techniques based on heuristics and economic judgements Gabriel Muinos...

Cognition After this session you will be able to understand how people make economic judgements identify heuristics spot the use of techniques based on heuristics and economic judgements Gabriel Muinos [email protected] Session today How do people process information and make economic judgements? 1. Prospect theory 2. Heuristics and biases 3. Break 4. Application observing a real case How do we make economic judgements? Using reason and applying logic Maximizing the utility Systematic thinking Applying logic rules Understanding inferences Testing this idea: Pick one of the following options: 1. Prefer not to play 2. Toss a coin. If heads, I give you 100 €. If tails, you give me 100 € How do we actually make decisions? Prospect Theory (Kahneman & Tversky, 1979) Loss aversion Asymmetry between perceptions of gains or losses We like gaining things, we dislike losing things but we dislike losing more than we like gaining Losing is around 2.25 times stronger than gaining How do we actually make decisions? Prospect Theory (Kahneman & Tversky, 1979) Loss aversion Pick one of the following options : 1. Prefer not to play ← 2. Toss a coin. If heads, I give you 100 €. If tails, you give me 100 € To get most people to play: We would need to offer more than 225 € if the person wins How do we actually make decisions? Prospect Theory (Kahneman & Tversky, 1979) Gains or loses reference points Gain 1. I give you 10 € 2. We toss a coin. If heads, I will give you 20 €. If tails, I will give you nothing. Loss 1. You give me 10 € 2. We toss a coin. If heads, you give me 20 €. If tails, you give me nothing. How do we actually make decisions? Prospect Theory (Kahneman & Tversky, 1979) Gains or loses reference points Gain 1. I give you 10 € 2. We toss a coin. If heads, I will give you 20 €. If tails, I will give you nothing. Loss 1. You give me 10 € 2. We toss a coin. If heads, you give me 20 €. If tails, you give me nothing. How do we actually make decisions? Prospect Theory (Kahneman & Tversky, 1979) Gains or loses reference points Gain 1. I give you 10 € ← 2. We toss a coin. If heads, I will give you 20 €. If tails, I will give you nothing. Loss 1. You give me 10 € 2. We toss a coin. If heads, you give me 20 €. If tails, you give me nothing. ← How do we actually make decisions? Prospect Theory (Kahneman & Tversky, 1979) Gains or loses reference points Gain = Risk aversion 1. I give you 10 € ← 2. We toss a coin. If heads, I will give you 20 €. If tails, I will give you nothing. Loss = Risk seeking 1. You give me 10 € 2. We toss a coin. If heads, you give me 20 €. If tails, you give me nothing. ← Prospect Theory (Kahneman & Tversky, 1979) Loss aversion We like getting things but we dislike losing things even more Reference points If gain: Risk aversion If loss: Risk seeking We are not calculators but then what are we? Efficient information processors Heuristics Shortcuts or rules of thumb Simple rules for quick decisions Biases A judgement that does not follow logic A bias is usually the outcome of an heuristic Using heuristics we will either reach the most logical conclusion or be biased (we will not know but we will be fast)  Availability heuristic We make decisions based on information But information can be activated more or less easily We make decisions based on easy to access information Some features of easy to access information: Recent, frequent, extreme, negative It is a good predictor most of the times!  Anchoring An initial value is used as a reference point The assessment of the value of a product is affected by the anchor It happens even when the anchor is irrelevant for the judgement itself  Anchoring Experiment Tversky & Kahneman (1974) Rigged wheel 10 65 What is the proportion of African countries that belong to United Nations?  Let’s see if you know I will show you some images and texts You vote which answer is correct Not only availability and anchoring This is a graphic representation of one heuristic. Which one? (a) Framing (b) Representativeness (c) Availability (a) Representativeness heuristic (b) Anchoring effect (c) Correlation vs Causation  (a) ignoring base rates (b) correlation vs. causation confusion (c) consumption of mozzarella helps to obtain engineering doctorates  (a) Anchoring effect (b) Representative heuristic (c) Sunk cost fallacy This is an example of the… (a) availability heuristic (b) confirmation bias (c) anchoring effect (a) Anchoring (b) Hindsight (c) Availability Questions? Endowment and marketing Structure Observation Endowment effect Frequently used techniques Systematic observation Which product? End Endowment (likelihood of object retention) Loss aversion Psychological ownership Endowment (likelihood of object retention) Loss aversion A loss has a greater psychological impact than a gain Car test Software free trial Microtransactions and DLCs Psychological ownership Free return Non-transferable positive valence of the object Grab and touch Interaction Self-referential memory effect Customization Personalization … Frequently used techniques? Tour  Cognition After this session you are able to understand how people make economic judgements identify heuristics spot the use of techniques based on heuristics and economic judgements Gabriel Muinos [email protected]