Thinking, Fast and Slow

Thinking, Fast and Slow

by

Daniel Kahneman

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Thinking, Fast and Slow: Part 4, Chapter 32 Summary & Analysis

Summary
Analysis
The main motivators of money-seeking are not always economic, Kahneman writes. For example, two sports fans travel 40 miles to see a basketball game. One of them paid for his ticket; the other got it for free. A blizzard is announced for the night of the game. The fan who paid for his ticket is more likely to brave the blizzard, otherwise he will have lost both the game and the cost of the ticket. He has attached an emotional value to the game and to the ticket.
In this chapter, Kahneman broadens the idea of loss aversion to apply to goods and situations. The fan is afraid of losing both the ticket and the experience of the game, and therefore braves a potentially dangerous situation.
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A related issue afflicts individual investors when they sell stocks. If they have to sell a stock, they would rather sell a stock that has earned money than a stock that has lost money. But the only consideration according to the rational economic model should be whether the stock is likely to do well in the future, not the original buying price.
This concept again supports prospect theory. The main consideration for the investors is not the value of the stock, nor is it the money that they could gain by holding on to one stock over another. Instead, it is the reference point—whether a given stock has lost or gained value.
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The decision to invest additional resources in a losing account is known as the sunk-cost fallacy, a costly mistake. Kahneman asks readers to imagine a company that has already spent $50 million on a project. The project is behind schedule and the forecasts of its returns are less favorable than they had been. An additional investment of $60 million is required. An alternative proposal is to invest in a new project which might bring higher returns. All too often a company afflicted by sunk costs will make additional investments to avoid a sure loss.
The sunk-cost fallacy serves as another example of loss aversion. Even though rational deliberation would reveal that it is better to invest resources in something that has a better chance of an outcome, we are extremely hesitant to take the sure loss that would come with admitting that the original $50 million investment was for nothing.
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Fear of regret is also a factor in many of the decisions that people make. It is often triggered by the availability of alternatives to reality. For example, consider the following scenario: Mr. Brown almost never picks up hitchhikers. Yesterday he gave a man a ride and was robbed. Mr. Smith frequently picks up hitchhikers. Yesterday he gave a man a ride and was robbed. 88% of people believe Mr. Brown will experience more regret, while only 23% will believe that Mr. Brown will be the most severely criticized. Both serve as comparisons to the norm.
Fear of regret is yet another manifestation of loss aversion, particularly when our actions cause us to deviate from our normal lives. We feel regret over the alternate reality that we have lost: in this case, Mr. Brown’s usual behavior of not picking up hitchhikers.
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Intuitions about regret are remarkably uniform. In an example, Paul owns shares in company A and considered switching to stock in company B but decided against it. He learns that he would have been better off by $1,200 if he had switched stocks. George, on the other hand, owned shares in company B, but then switched to company A. He also would have been better off by $1,200 if he had kept his stock. 92% of people believe that George feels greater regret. Situations outside the norm will garner more regret, particularly if one takes action (as opposed to inaction).
This example is comparable to Kahneman’s earlier assertion that goods gain value when we own them. Because George gave up the stock that he owned, and then lost money, people believe he took a greater loss than Paul, who merely forewent a gain by not switching stocks.
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The fear of regret favors conventional choices: even life-or-death decisions can be affected. In the case of a physician with an ill patient, the physician may prefer the normal choice over an unusual treatment, even if the unusual treatment may improve the patient’s chances. The physician who prescribes the unusual treatment faces risk of regret, blame, and perhaps litigation.
Kahneman demonstrates how loss aversion can cause us to make conservative decisions, possibly to the detriment of a better outcome, because we fear the consequences of making an abnormal decision so much, and because it is easy to imagine what might have happened under the normal circumstances.
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People become particularly loss-averse when they might bear some responsibility for the loss. In a scenario, you have been exposed to a disease which leads to a quick and painless death. The probability that you have it is 1/1,000. There is a vaccine available that is effective only before symptoms appear. People are willing to pay a significant but limited amount for the vaccine.
In this example, people bear no responsibility for risk, and thus they are less loss averse (even when they may be exposing themselves potential fatal consequences) than if they choose to expose themselves to risk.
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In a variation, volunteers are needed for research on the same disease. People must expose themselves to a 1/1,000 chance of contracting the disease. What is the minimum you would need to be paid in order to volunteer? This price is usually much higher, because people consider the regret they may feel if they realize they have sold their life.
In addition to the responsibility that the people in this example feel for their own deaths, there is also a greater fear of regret because they took action to cause a bad outcome, rather than choosing inaction to cause a bad outcome, as in the example of Paul and George earlier.
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Kahneman reintroduces the example from Chapter 29 of parents who are buying an insect spray. He writes that respondents were then told to imagine that there is a less expensive insecticide was available, for which the risk rose from 15 to 16 per 10,000 bottles. Many parents responded that they would not purchase the new product at any price. This is understandable, but money saved from a minute increase in risk may be used for other safety equipment. The real concern for parents in the scenario is the fear of regret.
This example of the insect spray is not only made by loss aversion, but also by the issue of narrow framing. With a narrow view of safety, parents believe that they would never want to expose their kids to risk, when in fact there are many safety concerns. The issue is that it takes a lot more deliberate thought to consider that this increase in risk is negligible.
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We spend a good deal of our day anticipating the emotional pain we inflict on ourselves. But we can inoculate ourselves against regret by remembering that we considered the possibility of regret before making decisions. If we are thorough when making decisions, we can prevent ourselves from saying “I almost made a better choice.”
Kahneman’s advice for avoiding the loss aversion inherent to regret is to understand that foregoing a different reality is not, in fact, a loss. If choices are made deliberately, we insure ourselves against the loss of having done something differently.
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