Making Sense of Irrationality!“Opening the Black Box”

By: Humayun Khan

Who is this “Homo Economicus”?

• Supremely RATIONAL

• Examines Evidence

• Conducts a cost/benefit analysis before making a decision

Introducing “Homo Sapiens”

• “Homo Economicus” model not disproved because we “SOMETIMES” make mistakes.

•The proof lies in that in certain circumstances, we “ALWAYS” make mistakes.

Amos Tversky & Daniel Kahneman – The Founders of Behavioural Economics

Question•A bat and ball cost $1.10 in total. The bat

costs $1 more than the ball. How much does the ball cost?

Two Modes of Thinking•“I feel it in my GUT!”

•“Use your HEAD!”

Vs.

Key Points to Take Away•Representative Heuristic or The Rule of

Typical Things

•Availability Heuristic or The Example Rule

•Mental Accounting▫Sunk Costs

Read This!•Linda is a 31 years old, single, outspoken,

and very bright. She majored in Philosophy. As a student, she was deeply concerned with issues of discrimination and social justice, and also participated in anti-nuclear demonstrations

Ask yourselves…

How likely is it that she is:

A) Bank Teller

B) Bank Teller active in the Feminist Movement

How it works…•If it looks like one, than it is one…

•This heuristic uses past learning to make decisions in the present, and predict the future, in the face of illogical thinking.

Ask yourselves…

Which one causes more deaths?

a) Smoking

b) H1N1

Are you more likely to be killed by?a) b)

30% more likely to be killed by falling Airplane Parts•Forget “JAWS”, think more “RUDDER”…

How it works…•When people are asked to judge how

frequently something occur, people consult their memories for examples

•The easier it is for you find an example of an event, the MORE LIKELY or FREQUENT you think it is…

Why can’t you get a cab on a rainy day?

What to do with all that birthday money?•Pay rent, phone bill, utilities bill, cable

bill…NAWWWWWW……

•How about alcohol, ipod, itouch, laptop, blackberry, or some new clothes…SOUNDS MORE LIKE IT

How it works…•The concept of mental accounting states, that

the source of the money affects how it is spent.

•So, when the cab driver makes his daily amount in a few hours, he closes the mental account and goes home, rather then work his shift and make extra money

Pay Check OSAP Scholarship

Gift Money

Imagine…You arrive at a theatre and discover that you lost your ticket. Would you pay another $10 to buy another ticket?

Now, Imagine…•You are going to the play but haven’t

bought your ticket in advance. When you arrive at the theatre you realize you have lost a $10 bill. Would you still buy a ticket?

Sunk Costs

•Costs that have already been incurred and which cannot be recovered to any significant degree…

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That’s All for Now

•I hope you now know or at least have started to wonder about, why we don’t make sense (all the time, that is).

References:• Kahneman, Daniel, Paul Slovic, and Amos Tversky.

Judgment Under Uncertainty: Heuristics and Biases. Cambridge, UK: Cambridge University Press, 1982.

• Gardner, Dan. Risk: Why we fear the things we shouldn’t – and put ourselves in greater danger. Toronto, Ontario: McClelland & Steward Ltd., 2008