By Natalie Fujita

Economics is popularly labeled the “dismal science”: the study of making boring, bleak predictions about the production, distribution, and consumption of wealth by agents in markets. And yet, my first experience with economics reveals a field with so much more to offer. This experience came in the form of a book titled Thinking, Fast and Slow written by an unusually insightful author.

Daniel Kahneman needs no introduction, but here I will attempt to do just that. Kahneman is a psychologist by training, receiving his PhD here at UC Berkeley in 1961 (Go Bears!). Despite being an outsider to the field of economics, he won the Nobel Memorial Prize in Economic Sciences in 2002, along with Vernon L. Smith. His work, mainly in collaboration with longtime colleague and friend Amos Tversky, concerning heuristics and biases in judgment and decision making led to the creation of prospect theory and an entirely new branch of economics, behavioral economics. Behavioral economics is the study of psychological factors in decision making, in direct opposition to the ever rational Homo economicus of classical economic theory.

Thinking, Fast and Slow outlines this fascinating and groundbreaking research on irrationality through entertaining and touching anecdotes. The first section of the book deals with heuristics, or mental shortcuts, and biases, or irrational prejudices, which streamline the process of decision making to be faster and easier. Kahneman frames these concepts as a dichotomy between System 1 and System 2, the fast and slow thinking mentioned in the title. Whereas System 1 is automatic, stereotypic, and unconscious, System 2 is its antithesis: deliberate, logical, and conscious. When people are faced with difficult problems that require complex calculations, they make an unconscious switch from System 2 to System 1, substituting heuristics for algorithms, in a process called attribute substitution.

The three main heuristics that Kahneman and Tversky proposed were representativeness, availability, and anchoring. The representativeness heuristic states that people tend to overestimate events based on their similarity to other events. This was most famously demonstrated through the conjunction fallacy, or, as it is colloquially known, the Linda Problem. Research subjects were asked to decide whether a fictitious persona, Linda, with certain characteristics, including being outspoken and passionate about social justice, was more likely to be a bank teller or a bank teller active in the feminist movement. Of course, it is very obvious mathematically: the probability that Linda is solely a bank teller must be greater than the probability that Linda is both a bank teller and a feminist because it has less conditions. However, the leading information about Linda’s interests seems to be more representative of her being a feminist and so our brain is tricked into thinking that the probabilities are the other way around.

The availability heuristic connects the accessibility of information recall to estimates of probability. To illustrate this phenomenon, Kahneman and Tversky asked participants in a research study whether it was more probable that a word chosen randomly from a text had “k” as the first letter or “k” as the third letter. As it is much easier to think of words that begin with “k” than it is to think of words that have “k” as the third letter, participants were more likely to agree with the prior statement. In fact, a standard piece of writing has two times as many words that have “k” as the third letter as words that have “k” for the first letter. Just because something is easier to conceive of, does not make it more likely to happen.

The last heuristic theorized by Kahneman and Tversky is anchoring as adjustment. It posits that people make judgements through a process of adjustment away from an initial reference point or anchor. The framing effect, which states that people are more likely to take risks if they are framed with positive connotations, exemplifies this heuristic. Participants in Kahneman and Tversky’s experiment were asked to choose between two hypothetical treatments, A and B, to a deadly disease affecting a population of 600. Kahneman and Tversky found that subjects were more likely to choose Treatment A if it was framed positively, saving 200 lives, than if it was framed negatively, killing 400 people, despite having the same rate of success, one in every three given the treatment surviving the disease.

From their study of heuristics and biases, Kahneman and Tversky developed prospect theory which attempts to explain the faulty reasoning behind people’s irrational behavior. Prospect theory stems from the concept of loss aversion: people tend to avoid losses at all cost, so much so that losses are seen as much worse than gains of equivalent value. In practice, prospect theory means that people tend to be risk averse in choices related to gain, valuing certainty, but they tend to be risk seeking in choices related to loss, valuing loss avoidance. This asymmetry implies that people make decisions based on relativity to certain personal reference points, not based on hard absolutes as assumed in expected utility theory.

Later in his career, Kahneman began studying hedonic psychology, the study of pleasure and pain in relation to behavior and perception, perhaps to consider the effect that irrationality has on our experience of life. He hypothesized another dichotomy, this time between the experiencing and remembering selves. The experiencing self measures pleasure from moment to moment, in contrast to the remembering self which measures pleasure over time. People tend to favor the latter, focusing on perceived pleasure and pain at the peaks and end of an event rather than as additive totals. This contrast has interesting implications for the way that people experience well-being as life satisfaction, meeting social expectations, does not necessarily correlate with happiness, the well-being of the experiencing self.

So, according to all of Kahneman’s research, how ought we to live? Should we try to be more rational, more like System 2? And is there even any point, given how irrational he has proven that we are? I think Tversky, Kahneman’s partner in research, puts it best “People live under uncertainty whether they like it or not . . . Man is a deterministic device thrown into a probabilistic Universe. In this match, surprises are expected.”


No responses yet

Leave a Reply

Your email address will not be published. Required fields are marked *