Decision Making: Essays

Decision Making: Who’s making your choices for you? (1502 Words)

The unquestionable aphorism in classical economic theory is summed up in the statement “all humans are rational’ but the very opposite of that behaviour is what describes its as humans. In reality, it is foolish to expect humans to behave rationally. Hence, while this assumption has helped formulate some fundamental economic concepts, it is important to note that this postulate loses its relevance as one goes deeper into studying human behaviour and the factors affecting it. The resultant gap that is created in the study of human behaviour in relation CO economic outcomes is hence filled by the nuanced discipline of Behavioural economics.

Behavioural economics deep dives into our inability to make rational decisions and examines the psychological biases that factor into the same. Needless to say that the study of behavioural economics bases itself on the truth that human beings make complex economic decisions that arc, at most times, then, far from rational. This in turn, makes it one of the most intriguing and sensitive fields to explore considering its close interplay with human psychology. A crucial aspect of behavioral economics are the biases and nudges. Some of the biases we talk about in this article are: The Confirmation Bias, The Loss Aversion Bias and the Sunk Cost Fallacy.

Confirmation Bias
A person, A prefers fast food for a number of reasons. A reads in an article that fast Food is detrimental to his health. and so he stops eating it. A while later, he watches a video by a fast food joint that shows that their food is 25% healthier. Almost immediately. A resumes his habit of eating fast Food because of this piece of information and his pm-existing beliefs about fast food. This is known as the confirmation bias. It is when a person seeks favouring information that only confirms that person’s pre-existing notions. Sometimes, people have the confirmation bias where they ignore information that disrupts their expectations and focus on the ‘evidence’ that supports what they believe in. Here. A avoids all the negative and sought the positive stimuli to reconfirm his belief’s.

In this era of information overload, we are bombarded with opinions. With the staggering amount of information. the cognitive part of our brain interprets information in a way that enforces our view. Thus. conforming to the confirmation bias. Confirmation bias affects personal notions AND professional endeavours. An investor can steer the wrong way because he is influenced by confirmation bias and refuses to consider facts that do not coincide with his own.

Loss Avertion
This crucial bias is more commonplace than one can estimate. The crux of loss aversion is – losses loom larger than gains. To elaborate, it has been found through research that losses act as a better. more effective motivator than gains. Potential losses impact people with a multiplier effect as opposed to a potential gain which. relatively. does not have a deep impact. This psychological barrier that is observed in different forms in a majority of human beings, is one of the many biases that culminate into our irrational behaviour.

The dichotomy here is that despite being common, this bias is identified and taken into cognisance in times of decision making. Moreover, this theory of loss aversion further reinforces the greater effectiveness of a penalty Frame over a reward frame to influence behavioural change. Loss aversion can be explained with the following example.

Consumer A spends a certain amount to buy something to cat and realises only later that the quantity of his purchase is too much for him and that over-consumption will render negative utility, which leads us to the conclusion that he will only consume the commodity till it gives him a positive marginal utility but more often than not, his behaviour in real life begs to differ. A is more likely to be averse to the potential financial loss involved in wasting a certain portion of the commodity which acts as a motivator for him Co keep consuming that commodity even if that means he has to pay for his own dissatisfaction! This behavioural trait of holding on to a Failing deal is elucidated upon in more depth in an extension of the loss aversion bias, which is ‘sunk cost Fallacy’.

Sunk Cost Fallacy
Say you’ve been training yourself every day for a month For a 10 km marathon. The big day is here, you start off well. Eventually, your shin feels a mild muscular twitch and the scorching heat is getting troublesome. Would you stop, train harder and come again the next time or would you rather keep running? As explained under loss aversion, one would choose what they find best to avoid the bigger loss.

The sunk cost Fallacy, however, tricks one into believing that the investment made towards the apparent loss’ is irreversible or ‘sunk’ without analyzing the consequences of the influenced choice. It is the tendency of people to follow through an activity that does not meet their expectations, sometimes seen as irrational, only because of the resources they have already invested in it. If you choose option two, you fall into the sunk cost trap. The Fear of ‘wasting’ the effort you have put in previously has kept you away from making the choice of looking after your health, which may reap greater benefits if you let go.

Researchers say that this bias also exists in the minds of mice! Now that we have explained these three biases, it is necessary for us to look at the role that these biases can play in a larger scheme of things. To understand the effect of these biases, we keep in mind the macroeconomic aspect of the economies. A current issue that is threatening both the health of a lot of economies is the climate crisis. The Trump administration released its Fourth National Climate Assessment on 23rd November fast that highlights the ramifications of not taking necessary steps for adapting cowards these fast changing climate conditions.

This report is just one piece of information among the hoard of negative blitzkrieg that stands against President Trump’s stance of climate change being a ‘hoax’. A study conducted by Stanford University (2018) calculates the ‘cost’ of climate change on the global economy. According to this study, if no step is taken to decrease the rising temperatures, the global GDP would Fall by 15%, on the other hand, if some efforts are made towards avoiding the climate crisis they would create approximately 24 million jobs.

However, the President is indifferent towards these reports, studies and facts simply because it contradicts what he believes in, which makes this situation a classic example of the confirmation bias and as to how it doesn’t just affect the person holding this bias but, here, also the planet’s future. Hence, we arc not saying The President is wrong, it’s just that he may or may not be conforming to the confirmation bias. Addressing the general air around the climate crisis, a very strong evidence of climate denial comes to the fore. This primarily looks at the widely shared reluctance that people and companies hold towards making a switch CO a more sustainable lifestyle and production techniques. This phenomenon is called the endowment effect which makes losses count much more heavily than equivalent-sized gains.

Here losses threatened in two distinct domains: the losses directly related to climate instability, and the economic loss that established interests would incur in order to decrease emissions. In both the options, a major difference in the possibilities is that of a person’s worldview surrounding the topic, and the extent of their loss aversion.

For someone, who would prioritise working to tackle climate instability, is loss averse to the dire future consequences of nature whereas a person B who is only driven by his short-term, self interest will be averse to welcome any change that may require him cut down on emissions. In this situation, B’s prejudices will compel him to be complacent about climate, which carves out a crystal clear example of the sunk cost trap! As much as this feels like a detour, it is imperative for one to be cognisant of these dynamic behavioural tactics in order to favour the best alternative for the future of the world.

This leads us to the realisation that learning the effects of these biases do help us achieve the efficacy of various tactics. The worry, however, is that these tactics can manipulate, for instance, governments using the loss aversion bias in their favour and charging higher taxes on renewable resources. It thus becomes essential to know where the line between encouragement and manipulation is.

In conclusion, are the choices you make really made by you or just by the part of your brain that ho biases? Also, did you read this article because you fell into the sunk cost trap or because this article conformed to your beliefs?

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