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Bazerman - Chapter 1 & 2

Terms

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System 1 Thinking
Intuition

Fast, automatic, effortless, implicit, emotional and COMMON

Can operate at the same time or in conflict with System 2 thinking
System 2 Thinking
Reasoning

Slow, conscious, effortful, logical, and LESS-COMMON

Can operate at the same time or in conflict with System 1 thinking
Normative Decision Making
Perfect (ideal) decision making

Evaluate all info correctly to derive the best solution
Steps of Rational Decision Making
1. Accurately define the problem
2. Identify the criteria
3. Weight the criteria in importance
4. Generate alternatives
5. Rate each alternative on each criterion
6. Compute an optimal decision
Bounded Rationality
Decisions that are influenced by factors not directly tied to consequences are said to be bounded.

Most of the time our judgments are bounded or limited to some extent.
Decision Making Models
Prescriptive Models
The goal is to give us the best methods for making optimal decisions. Develop mathematical models.
Decision Making Models
Descriptive Models
The goal is to identify our mistakes and help us understand them.
Heuristics
A simplified strategy for solving problems.

Give us a "good" solution, not always the "best".

Automatic.
Availability Heuristic
Assess the probability of an event by the degree to which the event is available in memory.

Emotional and vivid events are more available.
Availability Heuristic
Ease of Recall Bias
Judge events that are easy to recall because they are more vivid or recent to be more more numerous.
Availability Heuristic
Retrievability
Biased on how our memory structures are organized
Availability Heuristic
Presumed Associations
Overestimate the probability of two events co-occuring based on the number of similar associations we can easily recall.
Representativeness Heuristic
Tend to look for traits an individual may have that correspond with previously formed stereotypes
Representativeness Heuristic
Insensitivity to Base Rates
When assessing the likelihood of events, we tend to ignore base rates if any other information is provided
Representativeness Heuristic
Insensitivity to Sample Size
Frequently fail to appreciate the role of sample size.

Larger samples are more likely to come closer to the average than small samples.
Representativeness Heuristic
Misconceptions of Chance
We expect a sequence of random events to look random even when the sequence is too short.

Gambler's Fallacy: "After some bad luck, I'm due."
Representativeness Heuristic
Regression to the Mean
We ignore the fact that extreme events are likely to regress to the mean on subsequent trials.
Representativeness Heuristic
Conjunction Fallacy
We falsely judge that two or more events that co-occur are more probable that a more global set of occurrences.
Affect Heuristic
Emotional Influences that are automatic and maybe out of our awareness.

More likely to be used when people are busy or under time constraints.
Anchoring
We make estimates for values based upon an initial value and make insufficient adjustments from that anchor.

Access information that is consistent with the anchor.
Conjunctive and Disjunctive Event Bias
We exhibit a bias towards overestimating the probability of conjunctive events and under estimate the probability of disjunctive events.
Over Confidence Bias
We tend to be overly confident of the infallibility of our judgments when answering moderate to difficult questions.
The Confirmation Trap
We tend to seek confirmatory information for what we think is true and fail to search for nonconfirmatory evidence.
Hindsight and Curse of Knowledge
After finding out whether or not an event occurred, we tend to over estimate the degree to which we would have predicted the correct outcome.
Question
Answer
Framing
We are risk ADVERSE when the problem is framed as a sure GAIN. We are risk SEEKING when faced with a sure LOSS. How a problem is framed, as a gain or avoiding a loss, determines our preference.
Prospect Theory
We are risk seeking with losers and risk averse with winners. As a result we hold on to losers too long and sell winnders too soon.
Negotiations
Concessions = Loss This is because the loss is weighted heavier than the gain in the exchange.
Misjudging Probabilities
We tend to underestimate the likelihood of high probability events and overestimate the probability of low probability events. We don't accurately perceive the likelihood of an event.
Certainty Effect
The reduction in the probability of an event has more importance to us when the final outcome is certain. We prefer to ELIMINATE all risk rather than just REDUCING it. Will invest a lot more in absolute certainty.
Pseudocertainty Effect
We are more likely to favor options that offer apparent certainty than those that only reduce uncertainty. Appearance of certainty is valued, even if the certainty is incorrect.
Transactional Utility
We judge the value of a the deal you are getting compared to what you would
Acquisition Utility
The value placed on a commodity.
Endowment Effect
We demand a higher price for something we OWN that something we WANT. The seller's price includes intrinsic worth and attachment to the item.
Price Quality Heuristic
We don't know how to judge quality. People often assume that a higher price equals higher quality. "Paying a lot must mean it's good." Substituting the price for knowledge of quality.
Mental Accounting
All money is not equal. A variety of mental accounts exist. (vacations, renovations, daily living) Generally more upset by a series of small losses than an equally valued single loss. The first dollar hurts more than later losses.
Rebate vs. Bonus Framing
Epley, Idson & Mak (2005) Found that when tax give backs were described as rebates they were less likely to to be spent than if they were described as bonuses. Rebate - implies getting OWN money back Bonus - Free Money
Omission Bias
When comtenplating risky choices, not acting is seen as less risky than acting. Actions generate more regret in the short-term... While not acting will generate more regret in the long-term.
Preference Reversals
Hsee (1996) Separate vs. Joint Preference Reversals We place a higher value on one option over another when evaluated seperately. We reverse our preferences when we consider the options simultaneously. There is a conflict with the Emotional (sys 1) and the rational (sys 2). The emotional is stronger in the separate evaluations. The rational is stronger in the comparison condition.
Preference Reversals Evaluability Hypothesis
Hard to evaluate attributes will have less impact in separate evaluations than in joint evaluations.
Discounting
The present is more vivid to us than the future. We view all gains and losses in the future as worth less than present gains and losses. Ex: Retirement investments and credit cards
Motivation & Affect
When what we want to do conflicts with what we should do.
Hyperbolic Discounting
Laibson, (1994) We view all gains and losses in the future as worth less then present gain and losses. The present is more vivid to us than the future.
Positive Illusions
We have an overly positive view of ourselves, the world and the future. Pos. Illusions enhance self-esteem and increase persistence. It is more difficult to have optimistic illusions when we are confronted with the hard facts. Facilitate coping with aversive and uncontrollable events. Help us maintain a belief in a just world and personal control.
Unrealistic Positive View of Self
We see ourselves as better than others. Common unrealistic traits: Honesty, cooperation, rationality, driving skills, health, intelligence, and morals. We ARE fairly accurate at predicting the behaviors of others.
Illusion of Control
The belief that we can control uncontrollable events and that our actions can guarantee a certain outcome. Origins of superstitious beh.
Self-serving Attributions
More likely to accept credit for collective successes and to accept too little responsibility for failures. Attribute failures to external factors. This allows us to protect our self-image.
Positive Illusions in Groups
We extend these pos. illusions to the groups we to which we belong. Desirable characteristics of an ingroup are internal, undesirable characteristics are caused by external factors. We also denigrate others who are more successful than we are.
Self-Serving Reasoning
We first determine the best outcome based on self-interest and then seek evidence to support it based on fairness. We tend to be more self-serving when we can attribute the benefits to our group rather than ourselves.
Affective Influences on the Endowment Effect
Feelings of disgust tent to lower the selling prices. Sadness lowers the selling price and raises the offer price. Sadness promotes the need for change.
Sadder but Wiser
Alloy & Abramson (1979) found that depression was linked to greater judgment accuracy. (more realistic self-judgment) Sadness may trigger more deliberative thought processes. But, sad people are more impacted by anchors. People in good moods are more optimistic. Fear & anxiety increase risk-aversion. Happy people use more stereotypes.(representative heuristic)
Fairness
Fairness is judged by how the situation is framed.
Ultimatum
Rationally we should accept any offer that is higher than zero. But we don't. Norms of equity lead us to reject offers that are unequal. They can also lead us to accept equal split offers prematurely. Tendency to offer more more equal amounts as a counteroffer, when we could get a better deal.
Concern for the Outcomes of Others
People are concerned with out their outcomes compare to the outcomes of others.(Equity Theory) The outcomes of others act as a key reference point in interpersonal decisions.
Procedural Justice
We care more about procedural justice when rating a specific outcome. We care more about absolute outcomes in a choice response. Self-interest is always more important. People CAN judge by equity, but often choose inequitable, but economically favorable.
Fairness Framing
Paid equally among company. Paid inequal in company, but more than would get at another company. Separate - Choose equal Together - Choose inequal
Overconfidence
Overconfidence leads people to believe in their own abilities and more ACTIVE investing even though, index funds outperform managed funds. Individual investors buy and sell too often. Men buy and sell more than women.
Optimism
Investors make overly confident decisions and maintain overly optimistic views of the future success. Scenrio Thinking: "Because I can imagine it, we think it is more likely to happen. - Not considering all the risks
Denying Randomness
We often believe that random events are not really random. We believe that a hot fun has done well because of the fund managers talent, not luck. We ignore regression to the mean.
Anchoring & the Status Quo
We stick with the default investment allocations. Keep what is given to us. When we do change, the change is smaller than compared with those that do not have a default allocation.
Procrastination
Investments Involve immediate expenditures(loses) for a future gain. Procrastination and Discounting: Initial Value is too much, future gain is ignored. Omission bias - difficult decision, so just not make a choice

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