Cognitive biases, heuristics -cognitive shortcuts- and phenomenology are compelling revelations that force us to put many things, until now taken as certain, in quotation marks, under suspicion, open certainties, in doubt.
Biology, neuroscience, psychology, anthropology, sociology, the science of history, among other disciplines, are revolutionizing thought and our approach to the experience and living of reality, to our apprehension of the world.
Our models and theories for describing, understanding, and comprehending cognitive processes and socioeconomic phenomena are under review; they do not cover all manifestations, nor are they sufficient to explain what we do, how, why, and for what purpose.
Three stories, three cases, to illustrate
1. The bowl of roasted cashews
This is a dinner at Richard's house, the host, to which his friends, both contemporary and older adults, were invited. Richard placed a bowl of roasted cashews as an appetizer to give time for the dinner to be ready.
As the preparation took longer than expected, the appetizer, instead of whetting the appetite, became an indicator of hunger, in view of which, the host discreetly removed the bowl and stored it in the pantry, hurried the preparation and started dinner.
Why did they do it? Anyone might think they were adults with full self-control, sovereign in their decisions. However, the facts showed that this self-control needed a little help given the situation and context; they needed a "push."
2. The wine-collecting friend
Since 1950, Richard's friend, colleague, and dean of the university's economics department—who also shares his name—has been collecting wines. Many of the bottles in his collection, which cost him $5 each, could sell for up to $100 today. Richard's policy is to buy bottles of wine and never pay more than $30, yet he refuses to sell his old bottles. This creates a contradictory value asymmetry: the bottles he owns are worth more than $100 to him—so much so that he doesn't want to sell them—but when it comes to buying a bottle of wine, he pays no more than $30.
The cognitive bias of loss aversion reappears, but with amplified; if you have something, it's considered more valuable to lose it than to gain it, influencing economic behavior that could be described as irrational. But there's an even stronger reason behind it: for him, as a collector, these bottles—their possessions—go beyond obtaining marginal utility or satisfying a basic need for food, or even social status. Their value is transcendental, so much so that it might seem irrational to most people. This cognitive bias, which considers value based on whether or not something is possessed—that is, on ownership—is called the Endowment Effect.
3. Richard and his friend Jeffry got.
Two tickets to a professional basketball game in Buffalo, a 75-minute drive from where they live. On game day, there was a snowstorm, and they were considering not going. Jeffry, who isn't an economist, argued, "If we've already paid full price for those tickets, we should go." A correct observation of human behavior, but according to economic theory, these incurred costs don't matter. Richard, who is an economist, wonders:
Why does what has already been spent—sunk cost—make the satisfaction of a need, desire, or whim more attractive? This sunk cost even affects the value even when those who possess the good or the right to the service—the satisfiers—have not paid for it.
Three economic behaviors that do not correspond to what was expected.
Discoveries and new paths
Findings from empirical studies in cognitive psychology and behavioral psychology, as well as behavioral economics, open new avenues.
In particular, the work of Israeli psychologists Daniel Kahneman and Amos Tversky in the 70s, such as "On the Psychology of Prediction" (1973), one of the findings of which is that people are willing to make extreme predictions based on rather weak evidence; "Judgment under Uncertainty: Heuristics and Biases" (1974), which shows that there are predictable judgment errors; and Prospect Theory (1979), which deals with decisions under uncertainty. This theory split the field of decision theory in two: a rational decision theory and a simple decision description theory that predicts what people do in particular circumstances like the cases mentioned. One bases decisions on what should be, based on marginal utility and mathematical formulas—pure logic. And the other shows what usually happens in practice, where the situation, the subject, and the context make the difference.
The first, known as Normative Decision Theory, the fundamental notion was sown by the mathematician Daniel Bernoulli in 1738, but the formal and modern version is due to the work of the Hungarian-American mathematician John von Neumann and the Austrian economist Oskar Morgenstern in 1944.
The second, known as the Descriptive Decision Theory, is attributed to psychologists Daniel Kahneman and Amos Tversky.
Other findings
“There’s no such thing as a free lunch” and “the fair price.” The efficient market hypothesis, formulated by the American economist Eugene Fama in 1970, has dominated all empirical and theoretical research in financial economics ever since. It has two components, which Richard Thaler identifies as follows: the “There’s no such thing as a free lunch” component; there is always a cost, always a risk to be taken, always an exchange of value in the transaction. The other component is that of the “fair or correct price”; every good or service has an “intrinsic” value, but to date, its estimation remains a mystery.
Business decisions can also be irrational more often than people think, economically speaking.
Decision and choice
Two economic behaviors have been of particular interest to economic science from the mid-twentieth century to the present: choices and decisions.
What to choose? What to decide? In the previous reflection, the subtle conditioning of what is paid attention to, what is perceived, chosen and purchased was exposed, all behaviors that were believed to be free, conscious, sovereign.
In practice, most of our decisions, such as choosing and buying, are not our own; sometimes it is because in the face of complex situations we do not know what to decide and other times because it is easier, mentally, to let others decide for us, other times we do not even realize it.
How many times have you read the terms of service and privacy policy before accepting them when opening a social media account or installing an app on your phone? How many times have you consciously responded to the notification requesting permission to install cookies in your browser to improve your user experience? Do you know what the permission settings are for sharing data, using microphones, cameras, speakers, contact lists, wireless connections, and other options in the apps installed on your phone? How many service plans does your mobile carrier offer? Did you choose yours, review it recently, or change it? If your answer is "I don't know," you're on autopilot.
Architecture of Choices and Cognitive Nudge
In 2008, economist Richard Thaler and jurist and academic Cass Sunstein developed the theory of Choice Architecture and Cognitive Nudge.
A menu in a restaurant, like the programming on a music or TV streaming service, whether online or on-demand, like a set of options in a prepaid or paid plan for a telecommunications service, is an Architecture of Choices; when you go to a supermarket and see only two or three brands of a product on the shelf, you are looking at an Architecture of Choices.
When this comes with a default option, it gives the push; over time, the default option will be the most chosen, not by preference, but by convenience.
Now ask yourself: Is it free? Is it sovereign?
Richard Thaler is a behavioral economist and in 2017 won the Nobel Prize in Science and Economics.
Economic prizes awarded by the Bank of Sweden in honor of Alfred Nobel. This reflection is based on his speech at the award ceremony. Daniel Kahneman received this prize in 2002.
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