Thinking, Fast and Slow

Thinking, Fast and Slow

by

Daniel Kahneman

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Thinking, Fast and Slow: Part 4, Chapter 31 Summary & Analysis

Summary
Analysis
Kahneman asks readers to imagine a pair of concurrent decisions. In the first, choose between A) a sure gain of $240, or B) 25% chance to gain $1,000 and 75% chance to gain nothing. In the second, choose between C) a sure loss of $750 or D) 75% chance to lose $1,000 and 25% chance to lose nothing. Most people prefer choices A and D. But Kahneman shows that if people consider both decisions together, choosing B and C is actually unequivocally better than choosing A and D together.
Chapter 31 explores the instinctual preference we have toward evaluating problems one at a time. Unfortunately, this instinctual preference can lead to unfortunate errors, because in this case, looking at the four choices globally leads to a better evaluation of the options, and subsequently a better outcome.
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The different perspectives to consider the problem are called “narrow framing”—considering them as two separate simple decisions—and “broad framing”—a single comprehensive decision, with four options. Broad framing will be superior in every case, even though Humans are narrow framers by nature.
The natural tendency towards narrow framing relates to the first few chapters. In this previous example, people have intuitive preferences that are easy to follow. People could calculate the more complex options, but our tendency towards laziness prevents us from doing so.
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Economist Paul Samuelson asked a friend if he would accept a gamble in which he could lose $100 or win $200 on the flip of a coin. His friend responded that he would accept if Samuelson let him make 100 of the same bet. This makes sense: the aggregated gamble has an expected return of $5,000, with only a 1/2,300 chance of losing any money. But it illuminates the broad/narrow framing issue: if he encounters the offer on two separate occasions, he will turn it down both times. However, if he bundles the two together, they are jointly worth $50.
The Samuelson gamble illuminates why it is important to not be risk averse in every scenario, particularly when there are favorable odds. Broad framing is both more complex and also goes against our instinctual emotions, which caution us against taking this risk.
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The combination of loss aversion and narrow framing is costly, but individuals can avoid it with discipline. Experienced financial traders shield themselves from the pain of losses with broad framing. Broad framing is also useful in creating risk policies, like “always take the highest possible deductible when purchasing insurance” and “never buy extended warranties.” It allows people to make consistent decisions that will ultimately be financially advantageous.
By creating a risk policy, people can help to combat their inherent laziness. Standard rules allow people to override their intuition, but still enable them to make better choices without having to think too hard—thus, curbing mistakes that arise from laziness.
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A risk policy is analogous to the outside view Kahneman discussed earlier: both shift the focus from the specific situation to the statistics of outcomes in similar situations. Using both helps alleviate two conflicting biases: the planning fallacy and loss aversion.
Both risk policies and the outside view help people to override their fallible intuitive predictions (in which they often place a great deal of confidence) in favor of deliberate thinking.
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Kahneman concludes the chapter with an anecdote from Richard Thaler, who had a discussion with 25 managers of a large company. He asked them to consider a risky option in which, with equal probabilities, they could lose a large amount of the capital they controlled or earn double the amount. None of them would do so. The CEO then asked all of the managers to take the risk. He adopted a broad frame that encompassed all 25 bets, counting on statistical aggregation to mitigate the risk.
Thaler’s story about the CEO demonstrates the real-world consequences of adopting narrow framing, and how even those who deal often with gambles can make the same mistakes. The broader view of the CEO represents the perspective that people should have over their decisions as a whole, instead of simply focusing on one decision at a time and being loss averse.
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