Today, we’ll talk about three big ideas from the career of Daniel Kahneman
Lesson summary
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Last week , you learned about the life and work of Daniel Kahneman, the psychologist considered the “grandfather” of behavioral economics. He had a long academic career; he collaborated with many of the leading minds in psychology and economics; and he won the Nobel Prize in 2002.
But we didn’t have time last week to talk about the major insights from Kahneman’s career—so that’s what we’ll do today. I’m only going to talk about three major ideas. And we’ll only be able to scratch the surface . But by listening today, you’ll know more about his work and, maybe, you’ll be interested enough to read one of his books.
In the second half of today’s lesson, I’ll show you what it means if something sticks with you.
This is lesson number 678, so that means you can find the full lesson, including the quiz and exercises, at PlainEnglish.com/678.
Three big ideas from Daniel Kahneman’s career
Today, we’re going to look at three themes from Daniel Kahneman’s behavioral science research. The first theme is “prospect theory.” That’s the idea that the Nobel committee cited when awarding him the Nobel Prize for Economic Sciences in 2002. Then, we’ll look at his work on human decision-making . That formed the basis of his bestselling book “Thinking, Fast and Slow.” And finally, we’ll look at the serious flaws in human judgment , which he described in a book called “Noise: A Flaw in Human Judgment.”
Let’s start with prospect theory. The main insight here is that people value pleasure and pain asymmetrically . That is to say, we feel less pleasure from winning than we feel pain from losing.
If one day, you find $100 on the sidewalk , you’ll be happy. If on another day, you lose $100 in cash accidentally , you’ll be sad. But even though the amounts are the same, we experience the sadness more. It will stick with you longer. You’ll feel more pain about losing than you felt pleasure about winning—even the same amount.
Knowing this can be useful as we think about our own lives. Take just one example: investing in the stock market . Every day—and in fact every moment of the trading day —you can see your investment performance go up and down.
Prospect theory shows that people will react more strongly to negative news than to positive news. As a result , many individual investors sell investments at the wrong time because they felt the pain of bad days more intensely than they felt the pleasure of good days.
What can we learn from this? Maybe we learn not to check our investment performance every day or every hour—instead once a month or once a quarter . That would prevent us from reacting emotionally to the ups and downs (but mostly the downs) of the market.
Kahneman’s most famous book is called “Thinking, Fast and Slow.” In the book, he develops the idea that humans have two ways of making decisions, called System 1 and System 2.
These two systems of decision making evolved in human brains long ago. System 1 is the fast-thinking system, the system that makes instant judgments based on instinct and memory. Driving on an empty road is a System 1 task. System 2 is the slow-thinking system, where we think carefully and methodically . Parking in a tight parking space is a System 2 task.
There are many insights in the book, too many to list here. But one of the big insights is this: System 1 uses heuristics , or shortcuts , to make a quick decision. The shortcuts are good enough. They help us make fast decisions. For most of human history—and even in the present—we gain an advantage from making quick decisions that are good enough.
Often, it’s better to make a good-enough decision quickly than to spend forever making the perfect decision. Often, but not always.
Kahneman was not the first to identify the two modes of decision-making. But he designed experiments to show exactly how these two systems work. Here’s a great example.
One of the shortcuts our brains use is called “anchoring.” We evaluate something relative to something else —even if that something else is irrelevant .
Here’s an example. Let’s say someone advertises an online course that costs $199. You might think about it and decide that this is too much money; you would get maybe $100 in value from the course, so paying $199 is too much. This is a great example of System 2, the slow-thinking system, giving you a good result.
But now let’s imagine the company says the original price of the course was $2,000 and now this course is on sale for just $199. System 1—the fast-thinking system— jumps into action , using a heuristic called “anchoring.” It anchors onto the “original” price, $2,000. Then in an instant, System 1 decides that the course is a major discount off the original price, and therefore a great value. System 1 makes the decision before System 2 even has a chance to get started.
What can we learn from this? If you find yourself making a quick decision using shortcuts, slow down, think about it for a day, try to use System 2 as much as possible for the important things.
Kahneman’s most recent work was on “noise.” Noise, in statistics , is variability that has no explanation, just randomness .
Kahneman co-authored a book called “Noise: A Flaw in Human Judgment.” This book showed that humans think we’re really good at making judgments, but actually we’re far worse than we think we are. A judgment is a situation where you look at a set of facts and make a decision where there is no objectively-known answer.
Many professionals have to use judgment in their work. Teachers assign grades to student assignments, doctors examine patient X-rays, judges hand down sentences , business owners provide price estimates to customers.
The problem is that humans, even trained professionals , come to very different judgments even when looking at the same set of facts. So even when there should be no variation , or only a little variation, there is actually a wide variation in the way we interpret the same set of facts.
Let’s look at one example. In the U.S. justice system , a jury often decides if a defendant is guilty or not. But if the defendant is guilty, then it’s a judge who determines the punishment . The judge uses his or her own judgment to determine the sentence. But the judge has a set of guidelines to follow. The guidelines are intended to make sentencing broadly fair .
Kahneman’s work on noise discovered that judges, even when faced with almost identical facts, they produce very, very different judgments. One judge might be very lenient , another very strict , even when they’re supposed to decide the same way. And even one single judge might make very different decisions on cases, depending on irrelevant factors like the time of day or the weather outside.
Another example is radiologists . They look at X-rays and determine whether, in their professional opinion , anything in the X-ray might be cancer. Kahneman’s work determined that individual radiologists often come to different conclusions , looking at exactly the same X-ray images, just at different times. This is the same trained professional person, looking at the same images, coming to different conclusions just days apart .
This is not to blame judges or radiologists. These are just two examples of how we humans can be very inconsistent in our judgments, even when we think we’re being consistent.
Jeff’s take
The books I mentioned are both translated into many languages. Even if you’re not interested in economics or psychology per se, you can still learn a lot from these books. Here they are: “Thinking, Fast and Slow” and “Noise: A Flaw in Human Judgment.” Both by Daniel Kahneman, the second book with two collaborators.
In the section called “Dig Deeper,” I’m going to link to an episode of a podcast called “Hidden Brain.” And this is an episode that includes two long interviews with Kahneman, so you can hear him in his own words talk about his career and his experiments.
To find that, go to PlainEnglish.com/678, click on the transcript for the story, and then the tab called “Dig Deeper .”
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