Book Review (Thinking Fast and Slow)
The book Thinking Fast and Slow is a summary of a research that Daniel performed over the years about all the three phases of his career. His work covered cognitive biases, happiness, and prospect theory. The main thesis of the books was the two modes of thought in human existence. The first one he referred to as system one, and it is fast, emotional, and instinctive. The second system was system two, and it entailed a thought that was more deliberative, logical, and slower.
The book discusses the two reactions, which he refers to as rational and non-rational triggers or motivations, and associates each with a thinking process. He further continues on how they complement each other from his Loss aversion research. This goes from framing choices to explaining people’s tendencies and how to replace a difficult question with one that is simpler to comprehend or answer. This book summarizes how people might have evolved over several decades, but their thinking has not changed because they have always been too confident about their judgments and decision making. It also illustrates both the limitations and brilliance of the human mind. . The following essay is going to elaborate further on the details of this book and how it explains human nature in reference to our mentality.
Daniel writes this book in the perception of a layperson’s introduction to exploring psychology and results in a summary of some of the significant results of the last four decades. In this process, he gives a high-level elaboration of the scientific methods that are applied in the arts of creating a hypothesis, a significant amount of information on data analysis, smart experiments to test his theories and finding, and the lessons he learned in social science. He shows how slowly the process took with an elaboration of how sure he was, he would achieve his goal in conjunction with other researchers and understand the theories behind human thinking. Daniel also recounts the previous finding and history on the topic going back as far as the era of the great rational thinkers, Bernoulli, who is famous for the famous scientific Bernoulli equation, and David Hume, who was a Scottish philosopher.
At the end of his, research Kahneman illustrates that our brains have highly evolved over time to perform many and more complex tasks with great efficiency. Additionally, the brain can also be unsuitable to carry out other mental tasks because our behavioral misconceptions often influence our behavior. Consequently, this puts us at risk of manipulation from small increments and nudges and not from the normal overt kind. In this book, one gets to learn that by exploiting our weakness and actions in the ways our brain process information, governments, social media platforms, media in general, and populist leaders, we are able to exercise a form of collective mind control. It is crystal clear that our personal thinking system’s faults get more attention and are exploited faster than the patches, which is applicable in this context.
Daniel illustrates the brain as two animated characters:
System 1: this is the part of the brain that operates automatically and quickly. This part uses little to no effort and no sense of voluntary control. This system can also be called impulse.
System 2: this system pays attention and allocates effort to mental activities that are needed allowing the brain to analyze situations and complex computations. The operations of this system are associated with the concept of subjective experience of need for concentration, choice and agency.
The two systems are not physical or literal but conceptual from this researches that have been done about the human brain and studies on human reactions to different situations. These two systems, in a way, have managed to coexist in our brains and collectively aid in the navigation of life. System 1 is the intuitive one, and that means that it cannot be turned off under any circumstances because it helps us perform most of the required analytical tasks in our day-to-day activities. These activities include recognizing friends, navigate our way home on familiar roads, know that 1+1=2, and, most importantly, identify the threat (Daniel).
System 2, on the other hand, can aid in the analysis of complex problems, do crossword puzzles, attempt a math exercise, attempt examinations and other tests, and so on. Even though system two is quite useful to the human mind, it takes energy and effort to work. This shows the way it uses the concept of shortcuts with directives from system 1 to solve these problems so as to use less time engaging. For example, the syllogism,
is considered by most college students to be correct. However, the concept is not fully correct, and we agree with this logic because intuitively, we know that lilies fade. This syllogism does not describe the world but the logic behind relationships. The energy required to analyze the statements fully is required for system two in order for someone to interpret them logically. However, system one often jumps to conclusions that the statement is true and convinces system two the same. It is true that when people believe false information, they only focus on the arguments that make it true and not on those that make it false, creating unconscious confirmation bias among most people (Daniel).
Below are the characteristics of System 1:
System 1 generally operates automatically and hastily with little to no effort in used, and there is no sense of voluntary control included, as mentioned initially. The system generates feelings, inclinations, and impressions. When these concepts are endorsed by system two, they evolve to become intentions, believes, and attitudes. System 1 can also form a systematic pattern of activated ideas in associative memory. The system can also be programmed by system 2 to change its behavior and mobilize its attention when a specific pattern is detected. It also links a sense of subjective ease to illusions of truth, reduced caution, and pleasant emotions (Daniel).
This system can also enforce skilled responses and create intuitions after adequate training from system 2. The system is also able to differentiate between surprising events from the normal. As it works fast, it is able to invent and infer the causes and intentions of situations and people. As it analyses causes and intentions, the system might often neglect ambiguity and ignore the doubt. The system is biased because of its capability to believe and confirm issues and situations without reasoning. This might lead to an exaggeration of emotional consistency, which is referred to as the halo effect. This system is called a mental shotgun on some occasions whereby it can analyze more than intended. It also has the ability to match intensities across scales from sizes to loudness (Daniel).
This system is wired to focus on existing evidence and ignore what they can’t see (absent evidence), therefore generating a limited set of basic assessments. It also represents sets by prototypes and norms and does not integrate them. System one frames decision problems limitedly, isolating one from another. In some cases, it can substitute a difficult question with an easier one, which is easier to comprehend and, therefore, easier to answer. This system has a tendency of reacting more to losses than gains and, therefore, overweights low probabilities over the higher ones. Finally, this system is often more sensitive to changes than states but shows less sensitivity to quantity (Daniel).
Below is a summary of the major misconceptions that Daniel identifies in the human mind
Our brains are excellent associatory machines, which essentially let us easily associate with words like green with lime. For this reason, we are predisposed to priming, in which a common connection is often invoked to sway us in a particular direction or towards a specific action. This is in relation to nudges and advertising using positive imagery to impress our brains to want to buy or use the product (Daniel).
As mentioned earlier, system one often uses shortcuts by taking the easier option in a question or situation, swaying system 2 to believe what is easier. Ease arises from the repetition of an idea, a primed idea, clear display, and even depending on one’s mood. It is studied that the repetition of false information can lead people to believe them despite them being untrue. This is only because the information has become familiar and is easier to process in comparison to the truth, which is unfamiliar (Daniel).
Jumping to conclusions.
Our system 1 is a machine that is wired to jump to a conclusion following the basis that the system only believes the visible evidence without considering the presence of absent evidence. This tendency is famously known as “What You See Is All There Is” (WTSIATI). WYSIATI can sometimes draw conclusions from misleading information and then decide to believe those conclusions. The side effects of the halo effect, framing effects, base-rate neglect, and confirmation bias are aspects of jumping to a conclusion in practice (Daniel).
One example of confirmation bias is when we want to confirm something by looking for evidence to support our beliefs than looking for evidence generally whether it supports our beliefs or not. Rationally, we are supposed to look for evidence that doesn’t support our beliefs because, in that case, it will subject our beliefs to a more significant examination. However, this concept is rarely applied in other subjects except in the case of pure science, whereby in science, the individuals involved get to create a null hypothesis, and they are allowed to research on those terms to prove their original claim to be right (Daniel).
Answering easier questions
Often in situations where we are needed to answer difficult questions or deal with complex situations, we transform them into simpler situations or questions which are easier to answer. In other words, we use the heuristic rule; for example, when someone is asked, “How broke are you right now,” we often answer the question, “How much money do you have.” However, on some occasions, these heuristics can lead to incorrect conclusions (Daniel).
Law of small numbers
We all have a similar effect of an excessive amount of faith in small samples than larger ones. However, our tendency to seek elaborations and patterns leads us to a causal explanation of chance events that are often unsupportable and not right. Daniel says that he also falls victim to the inadequacy of sample size during his researches (Stojanović, 564-576) (Daniel).
The anchoring effect explains the tendency of the human mind to be influenced by irrelevant numbers. This leads to showing greater or lesser numbers from the real experimental numbers. This is a vital concept to have in mind before navigating a negotiation of prices or the value of something. Experiments on this effect have shown that our behavior is influenced more by what we want than what we know, depending on the environment or the moment we are in (Daniel).
Availability bias takes place when we take into account a projecting experience, something that is vivid in our brains or recent experience to make out judgments on issues or situations. There are several occasions when people with availability bias can illustrate their guidance from system 1. The first occasion is when they needed to engage in another effortful task at the same time. When they score low on a depression scale is also another case, and when they score high on a scale of faith in intuition. The concept can also apply when the person is in a good mood from something nice happening in their lives. Additionally, the case also applies when they are amateurs on the topic for discussion of the task in comparison to the true experts. Finally, this also applies when they are powerful or are made to feel so (Daniel).
This is the case whereby people use specialists on a specific aspect of life or education to aid in judging probabilities. There is only one way to resist the temptation of judgment by representativeness, whereby one can consider the base rate and make a judgment from it (Daniel) (Stojanović, 564-576).
Less is more
Given a description that, “Ruth is thirty-one years old, single, outspoken, and very bright. She majored in philosophy. As a student, she was deeply concerned with issues of discrimination and social justice, and also participated in anti-nuclear demonstrations. Which alternative is more probable?
In this case, the additional information or detail that Linda is active in the feminist movement in the second answer only serves to make the probability of choosing the answer lower since it adds more restraint. However, the accompanying narrative that makes the second option less likely to be chosen as the answer is what makes it the answer. This is a good elaboration of the statement above; less is more (Daniel).
Causes Trump statistics
The findings and conclusions from most researchers are that people are poor at reasoning statistically because we have a limited ability to think in Bayesian terms even when they are supplied with obvious and relevant background information. Bayesian inference is commonly known as the method through which people reason about likelihoods given before a general condition. For example, he uses this examples:
“A cab was involved in a hit-and-run accident at night. Two cab companies, the Green and the Blue, operate in the city.
What is the probability that the cab involved in the accident was Blue rather than Green?”
Apparently, a significant amount of people ignore the first fact that there are more blue cars than there are green cars. Kahneman answers the question using the Bayes rule as below:
A = Cab is blue, B = Cab is identified as blue; therefore, ⌐A = Cab is green, ⌐B = Cab is identified as green. So, we have:
P(A) = 0.15, P(⌐A) = 0.85, P(B|A) = 0.8, P(⌐B|⌐A) = 0.8, P(B|⌐A)= 0.2, P(⌐B|A) = 0.2
Thus, we want to know, P(A|B) = P(B|A)*P(A)/P(B), i.e., the probability that the cab was blue rather than green (and mistakenly identified).
And, we know from the Theorem of Total Probability that P(B) = P(B|A)*P(A) + P(B|⌐A)*P*(⌐A). Therefore, substituting, we get:
0.8*0.15/[0.8*0.15 + 0.2 *0.85] = 0.41, or 41%.
This Bayesian theory comes in handy in many practical situations like calculating the medical diagnosis for a patient, whereby there is a base rate of disease in a population and a test that could be 93% effective in identifying a disease. Under this topic, Daniel quotes two famous scientists Borgida and Nisbett, “Subjects’ unwillingness to deduce the particular from the general was matched only by their willingness to infer the general from the particular” (Daniel) (Stojanović, 564-576).
Regression to the mean
Regression to the mean is a statistical concept that explains that any sequence of trials will always eventually be converted to the expected value. However, we always look for causal explanations for lucky streaks and other sequences of numbers that seem to have any meaning in our lives (Daniel). There are several mental shortcomings in these contexts, such as:
The human mind always has an illusion of understanding, whereby we self-construct narratives to help us understand and make sense of the world and everything that happens around us. We often look for causality even where none exists. There is also an illusion of validity whereby stock pickers, pundits, and other experts have developed an inflated sense of expertise when there is no need for any. The other mental shortcoming is optimism and entrepreneurial delusion, whereby most people are always overconfident when coming to business, ignoring the fact that there will be competitors and assuming that they will outperform the average. Another one is the planning misconceptions, which affects most professions and stem from forecasting and planning that are often unrealistically close to the best case. It is important that they take into account and consider the actual results of similar projects. The last one is the expert intuition whereby even seemingly unprofessional ones, applications with discipline often outdo the expert’s performances (Daniel) (Stojanović, 564-576).
Bernoulli, expected utility, and prospect theory.
In this book, Daniel criticizes Bernoulli, who, more than two centuries ago, derived the utility theory, which in its essence elaborates people’s choices and the motives behind the choices in relation to the utility of the outcome. However, Daniel says that choices were not basically the mathematically determined expected value but were based on the utility’s psychological value. Here the human mind acts in ways that illustrate distaste in taking risks whereby people prefer sure bets to risks, even bets that are mathematically equivalent. For example, a good number of people would prefer winning five thousand dollars outright that betting on ten thousand dollars, with a fifty percent chance of winning. To explain further, the utility has always been related to the wealth or poverty of a person. This explains how when all possible factors are equal; a poorer person will buy the insurance to avoid risk loss while the richer one will act towards the risk (Daniel) (Stojanović, 564-576).
However, Daniel points out that Bernoulli’s theory only breaks down because it doesn’t consider the initial reference state. He gives an example:
“Anthony’s current wealth is 1 million. Betty’s current wealth is 4 million.
They are both offered a choice between a gamble and a sure thing.
The gamble: equal chances to end up owning 1 million or 4 million; or, the sure thing: own 2 million for sure.
In Bernoulli’s account, Anthony and Betty face the same choice: their expected wealth will be 2.5 million if they take the gamble and 2 million if they prefer the sure-thing option. Bernoulli would therefore expect Anthony and Betty to make the same choice, but this prediction is incorrect. Here again, the theory fails because it does not allow for the different reference points from which Anthony and Betty consider their options.”
In this case, Betty stands to lose her money and will be happy regardless of the situation, while Anthony is gleeful because he also gains regardless. “In Bernoulli’s theory, you need to know only the state of wealth to determine its utility, but in prospect theory, you also need to know the reference state,” this is the initial condition as said by Daniel. They also discuss the loss of aversion of a significant number of people when confronted with the expectation of losses; people often choose to make more effort avoiding losses even when probabilities show that they would still be no worse or better case scenario from the situation. This elaborates why people who find themselves in desperate situations often seem to engage in riskier behavior. To quote from the book, “people who face very bad options take desperate gambles, accepting a high probability of making things worse in exchange for a small hope of avoiding a large loss”(Stojanović, 564-576) (Daniel).
A lot of people in our society are more familiar with one concept of endowment effect known as the sunk cost fallacy. For traders and other people investing in businesses to avoid the sunk cost or the endowment effect, they need to invest their time in training and gaining experience. The significant difference seems to be whether or not goods meant for sale are held for use or trading. In other cases, the endowment effects are often larger (Daniel).
This is another measured phenomenon in the study of the human mind. It diffuses much of life from the regulations to the reforms that remove benefits from one group to another. This happens despite the result overall might increase the utility (Daniel).
People aren’t rational
The standard treatment of actors engaging in economics, in most cases, is perceived as rationality. However, Daniel explains that people are not entirely rational. They generally prefer less risk, whereby the human mind has a tendency to value the removal of risk over that of rationally reducing it to an acceptable level. Instead of people attaching value to the wealth, they have attached it to gains and losses(Stojanović, 564-576) (Daniel).
The four fold pattern
The prospect theory is summarized by the table below:
Daniel explains that the top left is the quadrant that Bernoulli discussed, whereby people are afraid of risk when considering prospects with a significant chance to achieve a large gain. They are willing to gain less for a lesser to no risk. The bottom left quadrant describes the possibility effect, which explains why lotteries are popular. When the top prize is large, ticket buyers appear indifferent to the fact that there are narrower chances of winning. The bottom right cell is where the insurance is bought. This explains how insurance companies are able to cover their expenses and still manage to make profits because people are willing to pay more for insurance than the expected value (Daniel).
The top right quadrant is where most unfortunate human situations happen. In this quadrant, most people chose to make desperate decisions like desperate gambles, accepting a higher probability of making situations worse than they already are in exchange for a small hope of avoiding a large loss. Taking such risks often worsens bad situations to disasters. They embrace the thought of accepting a large loss and its pain and the minimal hope of complete relief, which is also too enticing. In this case, defeat is so difficult to accept that the other opponents’ victory is quite predictable (Daniel).
Frames of reference
The framing effect is a knowledgeable bias where people choose options based on whether they are presented with gains or losses. People have a tendency to avoid risk when a positive frame is presented but decide to take the same risks if the frame presented is negative. Gains and losses, in this case, are described as outcomes. In the prospect theory, the loss is seemingly more significant than an equal amount of gain, and therefore a sure gain is more favorable than a probabilistic gain. In the same way, a probabilistic loss is better than a definite loss.
This prospect theory helps develop an understanding of the frame analysis within the social movement and the formation of political opinion where spin plays a significant role in political opinion polls that are framed in a way that they encourage a response that benefits the organization commissioning the poll. The frame analysis is very important to any business or organization because how a project, problem, or strategy is framed plays a very significant role in any organization. The same theory applies to the human brain, whereby how the brain comprehends a situation determines how the person or people around them react to it (Stojanović, 564-576) (Daniel).
Overwheighting the recent
People tend to overweight experience by comparing them with previous similar experiences, whether positive or negative. The human mind is trained to perceive an experience through the last episode results in their life of a similar experience. This is the same reason most people are not willing to face risks but decide on avoiding them. For example, a hiking experience that starts out badly but ends well seems like a good experience while vice versa is perceived as a negative experience (Stojanović, 564-576)(Daniel).
This book is an important summary of how the human brain functions from research throughout four decades, despite the criticism whereby he applies a precise interpretation to questions like the case on Linda, which wouldn’t be used by normal people. This is because people tend to use their contextual and cultural knowledge to form insights that exceed obvious facts. This would have been the most sympathetic explanation of the Linda problem in the attempt to explain the less is more concept. An example could involve taking to task someone for using the words literally and figuratively, which seems scholastic. However, in this case, and the nature of science, it is important to ask precise questions to achieve receiving answers that are narrowed down from what is ambiguous.
He also illustrates the rational animal favored by the enlightenment, Aristotle, and Plato and explains it in a different perception. He describes in the perception of it as a product of an evolutionary environment and, in many aspects, is badly equipped to deal with a rational, science-based logical world. He also explains how we can consistently continue being victims of our false beliefs and fears. Scientifically, the human race lacks the experience and knowledge to thrive, especially in the current world that is dominated by science and statistics. It is right to say that with the summary from this book, even the small number of people that are capable of thriving life are not able to manipulate others and command great wealth as a result.
Can we ever trust instincts- A quick study Daniel Kahneman on economic decision making
Published on 5th of February 2012
As mentioned above, the book Think, Fast, and Slow was written by Daniel Kahneman. It discusses how the human brain works to make decisions and weigh in options. The following is a book review that discusses how the knowledge of the book applies to economic decisions and policymaking.
What do we need to know about applying psychology to economics?
The is a common realization in a lot of people that they don’t always make sensible decisions that they wish would have made a positive and better impact on their policy. For most people who have taken the road of personal investments, unless there is access to illegal information, it is not advisable to trade in the stock market because their judgments might cost them a lot of money. For people to reduce the risk of costly losses, the choices offered to them by governments and institutions should be structured in a way that provides people with a viable option that they can use to opt-out of the transaction. Another issue in the business is the use of the measure of wellbeing to help guide policy. According to optimists, it is important for them to favor measures that improve the happiness of the population, while pessimists believe that it is e role of the policy to ensure that there is reduced suffering.
How would suffering be reduced?
The first step is to identify where the suffering is. Private grief, as the name precedes, is a personal problem, and the government can’t involve itself in this type of suffering. However, the suffering that should concern them should be emotional and physical suffering.
Would you equate those with poverty?
These concepts are not equally proportional to poverty despite the fact that in most cases, poverty has a great deal to do with them. Poverty brings in emotional suffering, but there are also others like loneliness. A policy can be made to reduce loneliness, especially among the elderly. This policy would help a great deal because their families mostly leave many older adults as they are working on a daily basis. The establishment of these institutions helps the elderly cub with loneliness and emotional suffering. Another vital focus would be a mental illness, which is a significant source of suffering. Increasing the support for the treatment of mental illness has also made a great impact on the lives of both the young and elderly. For example, commuting to and from work is a struggle and causes most people to stress and suffer physical exhaustion on a daily basis. To make this better, commuting could be improved, with better conditions, shorter and more convenient to reduce emotional and physical distress to the people.
Why don’t people make decisions that reduce suffering for themselves?
This part of the article is what brings together policy and psychological issues. The assumption that economic agents are completely rational brings in two conclusions. The first one is that people don’t need protection from their own choices. That line has been the most common line among economists in Chicago and is why they opposed social security. A big percentage of our population wants to save more than they actually save and have solid intentions to start saving the following year or month. However, helping them save would help them make decisions that they wished they would make.
The next conclusion is that people need a limited but enough amount of protection from the firms they interact with. This is because most people don’t read the conditions and guidelines. They often just move and click “I agree” without knowing what the contracts and terms and conditions apply. Ensuring that people are able to know and control what they agree with will be a significant part of any contract made. A large portion of our population needs to be taught to consider the terms and conditions as just as important as whatever they will get from agreeing with the conditions.
My Goal for the semester is to achieve my portfolio’s greatest return and see what sector gives the greatest amount of return. My strategy is to use technical analysis and rely on short to medium-term news. I will only be using equities this semester as it’s volatile enough for me. I want to learn more about investing equities, for it is something I want to do in the future.
As it is supposed to indicate the funds’ manager’s performance, the equities I chose was because of a mutual fund that outperforms the benchmark. This indicates that the equity I chose was efficient fund management. The Benchmark that I have decided to use is the S&P 500 due to myself focusing primarily on equities.
Asset allocations are described as the spread of investments across different asset classes. The initial plan was to fully invest in equities with no bonds, no futures, and commodities. This is because having long equities brings in more cash. I have a high tolerance for risk; therefore, it was easier to focus on the mid-cap equities, which have aggressive risks but very pleasing returns.
Experience in trading
The most important secret when it comes to trading and knowing or deciding what works best for you. Each asset class has its variations from the level of risk and return. Therefore, every investor should be ready to consider their tolerance for risk, time horizon, investment objectives, and the amount of money available for investment as the core to their asset composition. These aspects help an investor create an optimal portfolio. Investors with a longer time horizon could feel more comfortable taking the high-risk, high returns options; however, investors with small sums and shorter span investments may have to go with the low-risk low returns options. Additionally, many investment companies have created a number of model portfolios to ensure that the asset allocation process is easier for their clients. In each model portfolio, there are different proportions of asset classes that are meant to satisfy a specific level of investor risk tolerance ranging from conservative to extremely aggressive.
Daniel, Kahneman. “Thinking, fast and slow.” (2017).
Stojanović, Božo. “The Riddle of Thinking Thinking, Fast and Slow by Daniel Kahneman.” Panoeconomicus 60.4 (2013): 569-576.
Can we ever trust instinct? (n.d.). Retrieved December 01, 2020, from https://www.economist.com/prospero/2012/02/05/can-we-ever-trust-instinct
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