Judgement & Decision Making

• When analysing markets, a range of assumptions are made about the rationality of economic agents involved in the transactions
• The Wealth of Nations was written

  1776
• Rational


  (in classical economic theory) economic agents are able to consider the outcome of their choices and recognise the net benefits of each one
• Rational agents will select the choice which presents the highest benefits
• Consumers act rationally by


  Maximising their utility
• Producers act rationally by


  Selling goods/services in a way that maximises their profits
• Workers act rationally by


  Balancing welfare at work with consideration of both pay and benefits
• Governments act rationally by


  Placing the interests of the people they serve first in order to maximise their welfare
• Rationality in classical economic theory is a flawed assumption as people usually don't act rationally
• Demand curve shifting right

  Increases the equilibrium price and quantity
• Marginal utility


  The additional utility (satisfaction) gained from the consumption of an additional product
• If you add up marginal utility for each unit you get total utility
• Judgment and Decision Making


  Nov 28, 2023
• Wenjia Joyce Zhao
• Factors in decision making


  • Logic, probability theory
  • Evaluate options carefully (e.g., using mathematical computations) and choose the highest-value option
• Decisions based on deliberate computations can be unrealistic in many situations
• • Unknown information
  • Limited cognitive capacity
  • Changing situations
• How do people make decisions?
• Psychological factors in decision making
• People use cognitive shortcuts à heuristics
• Amos Tversky & Daniel Kahneman
• Heuristics and biases


  • Anchoring bias
  • Framing effect
  • Representative heuristic
  • Availability heuristic
  • Misunderstanding statistics
• Why use heuristics?
• Improve decisions
• Tversky and Kahneman, 1974: '"In general, these heuristics are quite useful, but sometimes they lead to severe and systematic errors."'
• Anchoring and adjustment


  1. Think of the last three digits of your phone number

  2. Add 400 to that number

  3. Think of the resulting number as a year

  4. Was Attila the Hun was defeated in Europe before or after that year

  5. In what year would you guess Attila the Hun was actually defeated
• Anchoring bias


  When estimating uncertain quantities, start from an anchoring number and gradually adjust the estimate by mentally "moving" from the anchor, often ending prematurely
• Anchoring bias


  • 42 accomplished judges, prosecutors with > 10y experience
  • High anchor: "The sentence for the defendant will be higher or lower than 3 years?" 33 months
  • Low anchor: "The sentence for the defendant will be higher or lower than 1 years?" 25 months
• Purchase of 75% lean ground beef

  Greasy or greaseless?
• Purchase of 25% fat ground beef

  Greasy or greaseless?
• Framing effect


  The wording of a description influences people's decisions even in equivalent situations
• Framing effect - Custody case


  • Parent A: Average income, average health, average working hours, reasonable rapport with the child, relatively stable social life

  Parent B: Above-average income, minor health problems, lots of work-related travel, very close relationship with the child, extremely active social life

  Award custody: 36% for Parent A, 64% for Parent B

  Deny custody: 45% for Parent A, 55% for Parent B
• Framing effect - Gamble


  • Begin with £0: Gamble A - gain £20 for sure, Gamble B - 1/3 chance to gain £60, 2/3 chance to gain nothing

  Begin with £60: Gamble A - lose £40 for sure, Gamble B - 1/3 chance to lose nothing, 2/3 chance to lose all £60
• Framing effect - Disease treatment

  • Treatment A: 200 people will be saved, Treatment B: 1/3 chance that all 600 are saved, 2/3 chance that nobody is saved

  Treatment A: 400 people will die, Treatment B: 1/3 chance that all no-one dies, 2/3 chance that everyone dies
• Events are independent, and H and T are equally likely, so any possible sequence of length six is as likely as any other
• Coin toss sequence

  • H T T H T H

  H H H T T T

  H H H H H H
• A series of outcomes with an approximate equal number of heads and tails is more representative
• Representative heuristic


  Judgment is based on how much the target looks like a representative/typical example of the class under consideration
• Representative heuristic - Linda


  • Linda is a bank teller

  Linda is a bank teller and is active in the feminist movement

  Linda is active in the feminist movement
• Representative heuristic - Calories

  • 312 Calories per 100 grams

  654 Calories per 100 grams