Thinking, Fast and Slow

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.

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.

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 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.

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.

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.