Slide 1

Behavioral and Experimental Economics Slide 2 Many decisions are based on beliefs concerning the likelihood of uncertain events Who will win the election? How will a $ trade for a tomorrow? Is the defendant guilty? What determines such beliefs? How do people assess the probability of an uncertain event or the value of an uncertain quantity? Slide 3 We reduce the complex tasks of assessing probabilities and predicting values to simpler judgmental operations. Resembles the subjective assessment of physical quantities such as distance or size. Example of how we judge the distance of an object using clarity. The more sharply the object is seen, the closer it appears to be. This is mostly right but subject to systematic errors. Slide 4 What is a heuristic? Why do humans use them? Do heuristics help or hurt human decision making? Slide 5 People use the simple probability to start and adjust from there, but they dont adjust enough Note that : Pr(disjunctive) > Pr(simple)>Pr(conjunctive) Due to anchoring: pr of conjunctive is overestimated and pr of disjunctive is underestimated Slide 58 Framing Hindsight bias Black Swans The Affect Heuristic Scope Neglect Overconfidence Bystander Apathy Slide 59 Framing refers to a situation whereby we fail to see through the way in which information is provided to us. In our pretest, I presented one question twice two different frames. Slide 60 The U.S. is preparing for the outbreak of an unusual disease, which is expected to kill 600 people. Two alternative programs to combat the disease have been proposed. The scientific estimates of the consequences of the programs are as follows: If program A is adopted 200 people will be saved. If program B is adopted there is a 1/3 probability that 600 people will be saved, and a 2/3 probability that no one will be saved. Which program do you choose? Slide 61 The U.S. is preparing for the outbreak of an unusual disease, which is expected to kill 600 people. Two alternative programs to combat the disease have been proposed. The scientific estimates of the consequences of the programs are as follows: If program C is adopted 400 people will die. If program D is adopted there is a 1/3 probability that nobody will die, and a 2/3 probability that 600 people will die. Which program do you choose? Slide 62 Program A200 14001 Live prob. Die prob. Program B600 1/36002/3 Program C200 14001 Program D600 1/36002/3 If you pick A over B, you should pick C over D Consistent Preferences imply: Slide 63 Question #9Question #12 Slide 64 Slide 65 Over-Optimism (Over Confidence) Bias AboveAverageBelow 20136067 Slide 66 Over- Optimism Bias Source: Global Equity Strategy, Behaving Badly (2006) Slide 67 Over-Confidence Slide 68 Slide 69 Illusion of Control (people think they can influence the outcome) Illusion of Knowledge (people think they know more than everyone else) Evolutionary Explanations of Overconfidence? Slide 70 Overconfidence and Natural Selection Slide 71 Tendency to look for information that agrees with our prior beliefs. Examples: - Iraq had weapons of mass destruction - God Exists (or God does not exist) - Corporations are bad - raising taxes lowers growth Slide 72 Failures of logic is an effective ploy to win arguments and winning arguments is an adaptive problem Arguing, after all, is less about seeking truth than about overcoming opposing views. So while confirmation bias, for instance, may mislead us about whats true and real, by letting examples that support our view monopolize our memory and perception, it maximizes the artillery we wield when trying to convince someone Confirmation bias has a straightforward explanation, argues Mercier. It contributes to effective argumentation. Source: http://www.newsweek.com/2010/08/05/the-limits-of-reason.html Slide 73 Frederick, Shane Cognitive Reflection and Decision Making, Journal of Economic Perspectives 19(4), 2005. Three Questions: - Bat and Ball - Machines and Widgets - Lilly pads Slide 74 Bat + Ball = 1.10 Bat - Ball = 1.00 Ball = Bat -1.00 Bat + (Bat -1.00) = 1.10 2 Bat = 2.10 Bat = $1.05 A bat and a ball together cost $1.10. The bat costs $1.00 more than the ball. How much does the ball cost? Ball = $.05 Slide 75 If it takes 5 machines 5 minutes to make 5 widgets, how long would it take 100 machines to make 100 widgets? 5 minutes Slide 76 47 days ! In a lake, there is a patch of lily pads. Everyday, the patch doubles in size. If it takes 48 days for the patch to cover the entire lake, how long would it take for the patch to cover half the lake? Slide 77 Group Mean CRT Score 0(%)1(%)2(%)3(%) MIT 2.18 7 1630 48 Princeton 1.63 18 2728 26 Boston fireworks Harvard 1.43 20 3724 20 Fund Mngrs 1.53 24 24 26 26 1.99 10 21 29 40 Sources: Frederick (2006) and B.E. Class Survey ucd(13) 1.24 (41%) 43% 15% 22% 23% Slide 78 Slide 79 Two parts of the brain: X-System (the default) Reflexive part in charge of perception. It is an effortless, fast parallel-processing system C-System Reflective, in charge of thought. It requires deliberate effort to use and is slow, but logical The CRT measures how easy it is for people to interrupt their X-System style automatic response Cognitive Reflection Task (CRT) Slide 80 People with high CRT scores are more patient The CRT was positively correlated with peoples attitude toward risk What explains variation in scores across participants? Slide 81 Gamble $100 for sure or a 75% chance of $250 % choosing risky option Low CRTHigh CRT Lose $100 for sure or a 75% chance to lose $250 54%31% $100 for sure or a 3% chance of $7,000 8% 21% Lose $100 for sure or a 3% chance to lose $7,000 63%28% Source: Frederick (2005) 19%28% Slide 82 Amounted need to win on toss of a fair die to balance 50% chance of $100 loss $152 CRT score of 2 or 3 CRT score of 0 or 1 $103.14 2011 Slide 83 You are going to play a game against the others sitting in this room. The game is simply this. Pick a number between 0 and 100. The winner of the game will be the person who guesses the number closest to two thirds of the average number picked. Your guess is: Slide 84 Correct answer: 0 Under the assumptions of rationality and common knowledge, this is the only Nash equilibrium x = 2/3*x x = 0 is only solution Slide 85 Slide 86 UCD Students 2013 0 1 2 15 17 20 21 22 24 27 34 35 36 40 45 47 50 67 68 27 40 50 2/3 average = 2/3(33) = 22 Slide 87 http://www.npr.org/blogs/money/2011/ 01/14/132906135/ranking-cute-animals- a-stock-market-experiment Slide 88 You are on a game show. You are offered a choice of one of three doors. Behind two of the doors there is a goat. Behind one of the doors there is a car. Upon you announcing what door you chose, the host of the show opens one of the two doors not selected by you, and reveals a goat. After he has done this, he offers you the opportunity to switch your choice. What should you do, stick or switch? Slide 89 Correct Answer: Switch Slide 90 Sources: Behaving Badly (2006) and B.E. Class Survey Stick Switch No Preference Fund Managers Mac 08 42% 65% 66% 48% 18% 34% 10% 18% 0% Mac 10 Slide 91 http://www.youtube.com/watch?v=cXqD IFUB7YU http://www.youtube.com/watch?v=cXqD IFUB7YU http://www.youtube.com/watch?v=OTos h1aZ5fs&feature=player_detailpage#t=8 8s Slide 92 The objective is not to laugh at how foolish we are, but to show just how hard it is to avoid falling into cognitive pitfalls. Why do we make them?