by Daniel Kahneman
For most of the twentieth century, economic thought was dominated by the concept of “the rational man”. This was a hypothetical economic actor who always acted rationally in his self-interest. He calculated costs and benefits of various decisions and chose the option that best suited his desires. It was a clean and simple concept, and a lot of economic theory was developed with the rational man at its foundation.
Although the concept worked beautifully in analyzing the behavior of corporations and businesspeople, it broke down badly when it was applied to regular people. They were always making decisions that didn’t fit the models; all the lovely economic theories broke down badly when applied to normal people.
There were a number of attempts to develop some kind of theory that explained this irrational behavior, and although there were some successes, those successes always seemed to be limited to some narrow aspect of behavior. Economists needed something that worked in a broader range of situations.
Into this gap stepped Daniel Kahneman and his “prospect theory”. It worked much better than previous theories, and so they gave him a Nobel Prize in economics. Huzzah for Daniel Kahneman!
This book is his attempt to explain the underlying concepts of prospect theory. It’s all based on hundreds of psychological tests carried out by Kahneman and others; the tests demonstrate the ways in which people behavior irrationally.
The most salient of these discoveries is the fact that people are more worried about losing what they have than gaining something more. For example, if people are presented with this choice:
A. A guaranteed payment of $75.
B. A 75% chance of winning $100.
They’ll usually go for option B, even though the two choices are mathematically indistinguishable. In other words, when the issue is what they’ll gain, they’re willing to take a chance. But when given $100 and presented with this choice:
C. A guaranteed loss of $75
D. A 75% chance of losing all $100
They usually take option C. The reason is that the anticipation of gain is never as powerful as the fear of loss. The sting of loss is always greater in absolute value than the pleasure of gain. This biases people’s decisions in hundreds of ways – and Mr. Kahneman drags us through every damn one of those ways. This book is a long, tedious parade of results of psychological experiments, all of which go to show how irrational people can be. I confess, some of the experiments are truly clever schemes for teasing out the subtler aspects of human cognition. And there are certainly many more ways that we miscalculate.
For example, we tend to overestimate the magnitude of risk. This is really just an extension of loss aversion, but Mr. Kahneman doesn’t seem to notice it. This is why people are terrified of plane crashes and terrorist attacks, and end up dying in car crashes instead.
Another factor that I don’t recall Mr. Kahneman mentioning is the difference between controlled risk and imposed risk. People are terrified of nuclear power plants because they impose risk upon people, but when in control themselves, they take far greater risks without blinking an eye.
This book, however, muffs its central thesis. Mr. Kahneman argues that our cognition is comprised of two separate systems, System 1 and System 2. Mr. Kahneman distinguishes between them based on their speed of execution: System 1 gives us answers instantly, intuitively, and often produces irrational results. System 2, however, is slow and deliberate, and is usually more reliable. He’s right, but he goes no further than this, which I found intensely frustrating, because the explanation is lying right out there in the open. The underlying distinction is between the parallel processing that is natural to nervous systems and sequential processing that forms the basis of formal logic (although sequential processing goes much, much further back in time). A explanation of the two can be found in my hyper book The History of Thinking. A quick introduction to parallel processing is here; the quick introduction to sequential processing is here. There’s much more about the difference between the two scattered through the entire hyper-document.
I didn’t finish the book; about 80% of the way through I lost patience with the endless cavalcade of psychological experiments all proving the same thing over and over.