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The Human Decision Process
Decision Mechanisms in the Human Mind
For a variety of evolutionary and biological reasons, the human mind is not as rational and logical as one might expect it to be. In fact, science has identified very well known biases and outright errors in our thinking. Some of these are useful to us for resolving problems and supporting long term memory. Unfortunately, some of these flaws in logic and reasoning create serious problems in our ability to deal with the complexities of modern society. Although these flawed decision mechanisms are with us all the time and affect every decision we make, they are most often a problem in matters related to business, money and risk. Con artists, salesmen, gamblers and market experts are very familiar with these issues and often exploit them in order to gain an advantage. There are, in fact, more than 40 well known and well defined innately flawed or biased decision mechanisms in the human mind and many of these have been known for more than 100 years. Below are just a few.
Principle of Regression to the Mean: A notion worked out by Sir Francis Galton (1822-1911), an English gentleman-scientist that, in any series of random events clustered around an average or a mean, an extraordinary event was most likely to be followed, just by luck of the draw, by a rather more ordinary event. This is not so much an innate human decision mechanism as it is a problem in how we deal with and understand this effect. Regression to the mean is why it is nearly impossible to flip a coin and have heads come up ten times in a row. The idea of a “run of luck” is often the basis of a perceived advantage in dice games. The numbers that represent the mean are to the house advantage and any other streak of good luck will eventually regress to the mean. One other common application is contrarian investing which works simply because regression to the mean predicts that the worst stocks get better. Unfortunately, it also predicts that the hottest stocks or a sudden rise in overall stock market performance will regress to a lower value. The degree of change and the potential for regression can be calculated mathematically to produce probabilities of risk with known computed percentages of certainty.
Representativeness is a mental problem-solving method that is a sort of short cut the mind takes in dealing with real-world problems that are so complicated they would choke a computer. The mind handles these complex problems by assessing the evidence intuitively and compares it to some mental model. If the two match, then the mind concludes that the event is more likely. For instance, to decide if a particular football team will win a game, the mind compares the team to its internal model of what an ideal team is like. If the two models match, then the mind concludes that the team will win. This works well for most of the time but does poorly when the derived conclusion runs counter to the laws of chance and probability. Such errors occur most often when the internal mental model is flawed. A case in point is the advertisements that create the idea that winning the lottery is easy. This creates an internal mental model in most people that they have a better chance at winning than they actually do causing them to make the decision to buy more lottery tickets in the hopes of gaining that mental image of a winning lottery winner. Much of Madison Avenue long term marketing campaigns is based on this flawed innate human decision mechanism.
Availability is a mental short-cut that occurs when people judge the likelihood of something happening by how easily they can recall other examples of the same thing to mind. Availability, too, appears to be a wonderful way to tackle complex problems because, in general, commoner events are more easily remembered. However, it does not always work for less well-known subjects. For instance - does the letter K appear more often as the first letter in a word or the third letter in a word? Most people judge that K is commoner at the beginning of words because it's easy to recall words that begin with K. Actually K appears about twice as often as the third letter in words. People overestimate the probability of large vividly imaginable causes of death and underestimate the likelihood of more common but less dramatic causes of death simple because vivid accidents are easier to picture in the mind. One of the tragic consequences of this logic error is that we, as a nation, vote billions of dollars for government actions to safeguard us from threats such as African Bees, Marijuana, Missile Defense (Star Wars) and other seemingly impending disasters despite the fact that few if any people have ever died from these dramatic causes in the past 25 years. In that same period of time, AIDS has killed 80 million people, automobile accidents have injured 90 million people, alcohol related deaths total to more than 2.6 million and tobacco killed more than 9.1 million. It has been said with some degree of realism that if a thousand people die slowly, no one cares but if one person dies in a spectacularly fast manner, thousands will react and demand a stop to the carnage. Availability is a mental decision mechanism that affects us on a daily basis with profound implications for our society and ourselves.
Framing is the principle that if a problem is framed (presented in a different manner) then the response will be different, even if the problem has not changed. In general, the frame that takes the broader view of a situation is more easily defended. Framing is often associated with pre-conceived cultural metaphors of something positive. Politicians are masters at using Framing to sway the voters to back their desired position. For instance, “tax relief” has been the frame proposed by the present administration to divert attention away from other frames of “tax burden” or “national debt”. Such refocusing is sometimes referred to as “spin”. Some Public Relation firms advise their clients to use “bridging language” that uses a strategy of answering questions with specific terms or ideas in order to shift the discourse from an uncomfortable topic to a more comfortable one. This is often a studied process to specifically exploit an innate human mental decision mechanism to obtain an advantage.
Most people find solving a problem quantitatively very unsatisfying and so they'll re-frame and re-frame the problem until they find a qualitative difference that's decisive. For example, a company might say, “This guy is more productive, but that guy is more creative. We need creativity, so we'll hire that guy.”
Prospect Theory says that there is something about the human mind that so abhors a loss that giving up some quantity of money, commodity or privilege is never fully offset by an equivalent gain. This is a subset of Framing that places the frame of a decision around the loss and/or the gain to be obtained. “Losses loom larger than gains”.
The notion that people are “risk averse” as decision theorists put it, has endured since the 17th century and has become a part of many economic models. People tend to avoid risks when seeking gains but choose risks to avoid losses. People need a strong inducement to gamble but they will expose themselves to tremendous risks in order to avoid a loss. The effect is particularly pronounced in jobs and careers, second only to life and death situations. People avoid risks when seeking to save lives, but choose risks when seeking to avoid deaths.
People avoid fair bets not because they are “risk averse” but because they are “loss averse” - the prospect of the gain isn't worth the pain of the loss. People find it easier to give up a discount (forgo a gain) than pay a cost (suffer a loss). A loss seems less painful when it is an increment to a larger loss than when it is considered alone. This loss avoidance bias is a central causality of a number of human behaviors that have been given names such as: the status quo bias, the equity premium puzzle, the endowment effect, reflection effect, disposition effect, intertemporal consumption and various gambling and betting behaviors. A great deal of study of this mental decision mechanism has been done in the fields related to economics (investing, gambling, budget planning, cash flow management, etc.). It is also a central influence in psychological research into happiness, which finds subjective measures of well-being are relatively stable over time, even in the face of large increases in well being. This seemingly subjective mental bias can be plotted on a graph and calculated based on a variety of heuristics and metrics and it can be quantified to support more objective decisions.
Common business management and economic decisions often involve several of these innate human decision mechanisms that combine in synergistic ways to amplify the bias or influence they present to the decision maker.
How do people formulate strategy? A manager or group of managers first decides what their opponents are likely to do. This is often based on framing the opponents in a pre-conceived model of who their opponents are and how they think. Then the managers decide how the opponents will respond - which is also framing. Then the managers decide how their opponents will react, and so on. The theories of Representativeness and Availability dictates that the more detailed these future scenarios become, the more likely they will seem - since detail makes an account more strongly resemble the real world. These are all assumptions that each are based on innate human biased logic that often is flawed to a considerable degree.
Let's imagine a scenario involving just seven such assumptions, each of which has a 90% chance of being right. This means that our flawed innate human biased logic has created only a 10% probability of error in each assumption. Such a small error might seem minor but when combined with a sequence of interdependent decisions, the cumulative error can be substantial. The overall odds of making a good decision would actually be somewhat less than 50-50 (.9x.9x.9x.9x.9x.9x.9=47.8%). Actions that acknowledge a high degree of uncertainty are often very different than actions that don't.
Ignoring the Base Rate or background data against which the probability of an event is judged is a common error. People will believe the odds are in their favor - “it won't happen to me”. Aids, cancer from smoking, losses in the stock market, criminal activity are all examples of this. This leads to a strong overconfidence effect. This is a classic example of how the human mind suppresses uncertainty. We're not only convinced that we know more than we do but that what we don't know must be unimportant.
“It's frightening to think that you might not know something, but more frightening to think that, by and large, the world is run by people that have faith that they know exactly what's gong on!”
Why people make irrational decisions….
Choosing instant gratification over long-term goals?
You're offered fifty dollars for your old bicycle but you'd like to lose weight over the summer by exercising using the bike. What do you do? Researchers at Princeton University have discovered that two separate brain areas are involved in the decision to choose short-term satisfaction or settle for long-term happiness.
These findings could be the first steps in understanding different types of impulsive behaviors, including acute addiction and attention deficit hyperactivity disorder, and could eventually lead to improvements in treatment, said lead author Samuel McClure, Ph.D., a neuroscientist and a postdoctoral fellow at Princeton's Center for the Study of Brain, Mind, and Behavior.
McClure and colleagues set out to answer a question that has long plagued economic theorists:
Why do people sometimes make seemingly irrational decisions,
choosing instant gratification
over long-term goals?
Until now, experts postulated a single decision-making process with a built-in inconsistency.
"Our study shows that there seem to be two separate brain systems involved in making intertemporal choices".
Using functional MRI (fMRI) studies, researchers examined 14 volunteers who were asked to choose between gift certificates ranging from $5 to $40. Volunteers could choose the larger amounts if they waited for a longer time, between two to six weeks.
For all the decisions, regardless of whether the reward was delayed, fMRI registered equal activation in two brain regions associated with abstract thinking: the lateral prefrontal cortex and posterior parietal cortex.
When subjects chose longer-term options, greater activity occurred in the frontoparietal region of the brain. Decisions for immediate gratification lit up parts of the limbic system associated with the midbrain dopamine system.
Although portions of the brain related to abstract thinking were activated during all decision-making processes, the limbic system, the portion most associated with emotions, won out over the abstract thinking regions when the reward was closer at hand, McClure said. The results were published in the October issue of Science.
While investigators now know that the limbic system is activated under conditions in which money is available immediately, and these areas of the brain are rich in dopaminergic innervation, they do not have evidence that directly links dopamine levels with their findings.
"We need to parse out how the limbic and lateral prefrontal systems interact in making intertemporal choices. Of particular importance is determining how this interaction works in determining individual choices," he said.
Summary
It should be clear by now that we humans have some inate problems in making completely objective decisions, even when there is a concerted effort to do so. Being aware of these biological and mental biases helps but still may not produce a truly objective analysis. Only by using provien decision support mechanisms, methods, techniques and tools can we hope to make the best decisions. BDM knows how to use these methods and how to apply and teach them to others.