Saturday, January 30, 2016

What have I learnt from Daniel Kahneman?

This article is my first serious attempt to understand Human Behaviour, written in form of a Concise Summary, highlighting the ideas of Nobel Prize winning Professor Daniel Kahneman who wrote the book, Thinking Fast and Slow. This article will make a good reading for anyone who wants to quickly understand Kahneman and will be of help in making better decisions, or atleast averting bad ones.
The debate of choice.

To begin with, in every decision of ours, we have a conflict between intuition and logic. We usually try to prevent the loss rather than focusing on achieving the gain.
eg. Take the case of Cab drivers in Rains. They should ideally drive more in rainy days as everyone wants a cab(as fast they can) while its raining (nobody wants to get drenched?). Though the cab drivers, who want to earn a said income everyday be it rainy or a sunny day, their daily wage, stay away in the rains. They dont realize that during a rainy day they have far better chance of earning than on any given sunny day. The gain they can achieve on a rainy day is way more than on a sunny day but they do not think in terms of achieving the gains only on averting the loss wherever they can.   

A question we can ask is, Are we very deliberative people? Who weigh the costs and benefits of every decisions of ours?
No. As per the work of Daniel Kahneman. We will look into this with the help of biases and the two systems of thinking. 

First lets see what is 'Inattentional blindness': It defined as an event which a person fails to recognize and event despite it occurs in his plain sight. It is a psychological blindness and not a perceptive one.  
eg. The 1995 case of a police officer, Kenny Conley, who failed to notice a fight( a set of other police officers who were beating up another suspect, who later died) which was happening in front of him. He said he was only observing the suspect which he had caught oblivious to the other one. He was prosecuted for perjury as everyone believed that he was telling a lie. 
Honestly we walk past so any things which are happening around us but we tend to be unaware of them. We make a lot of decisions without even realizing anything about our surroundings.

Daniel Kahneman, suggests the following two ways of human thinking,  
System 1: Fast (Intuitive, Basic Visualizations, Reflexive)and this is what drives us in most of the conditions. This is our Auto-Pilot mode. Sometimes it leads to a thoughtless creation of habits. Sometimes one bad decisions leads to another bad decision and we fail to realize this.   
System 2: Slow (Deliberate, Rational, Thought based) and here we follow some rules and it involves work, effort and concentration. 

There is a battle between these two systems of thinking. We tend to make a mistake when we use the wrong system for a decision. We tend to make decisions, based on our past ones. We assume that because we have decided something in the past we can continue on that decision. It is important to understand where do our beliefs come from.

Lets see what a bias is. 
It is a systematic error and is predictable. Over 150 Cognitive biases have been identified. Lets see some of them.

Like in the Present bias, we tend to think too much about the present and not think about the future. Halo effect, If we like something or an organization we tend to think that everything about it is good and vice versa. What we like is a good thing and that we dont like is a bad thing.  eg. we tend to disregard an attractive trait in a bad person. 
Spotlight effect, we tend to think that other people give a lot of attention to us but in practice they dont. Confirmation bias, is where we seek evidence of what we already know. eg. When we pin the allegation on the usual suspects. This is perhaps the most dangerous bias we have. Bias of Loss Aversion(the most important work to have emerged from Kahneman)  We tend to avoid losses than acquire gains. Effects of losses are twice as powerful than gains. This was taken up in the example of Cab Drivers.
These biases tend to explain a lot of wrong decisions which we make. eg. Our impulsive spendings, choosing the wrong person, not seeing the other person's point of view etc. These biases are all the more important when we are an expert and a lot depends on our decisions. Evolution as in turns out, has a lot to do with our biases. 

In Finance, these biases can have tremendous effects. We assume that finance decisions are very rational but in practice they are subjected to the similar biases. When Money comes in, it brings with itself a peculiar mode of thinking. Our decisions change when money arrives. We tend to think we are very rational in money matters. Though, this is debatable. Kahneman has given a lot of insights on our decisions with money. Our decision to gamble with money is very different when we have  made a gain vs when we have made a loss. We risk more when gain or a person will gamble more if he wins.

System 2, Slow thinking allows us to note that there is a System 1, the Fast and this realization can help us make better policy decisions and design better institutions for the world and also for ourselves. We have to change the environment we have build around us rather than to change ourselves. 

This article is an attempt to understand and is not a review by any standards of Behavioural Economics, Human Psychology or of Kahneman. 

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