As biased as it gets

 The previous time, I raised the subject of the rationality that we have in our everyday behaviors. Basically, no. I tried to raise the different point of view. That we do not actually act that rational when we take everyday decisions. So, when I asked for comments from a good friend of mine, he was not sure about the practicality of my article. This time I will try to be a bit more practical.

I will to explain three main cognitive biases that pretty much most of us have. But first let me tell you what a cognitive bias is. Let's say, that you were raised in a standard social environment, for example a small town in your country. In this town, all the citizens interact with one another on everyday occasions (going shopping and meeting a friend, go to the police station etc). So basically, all the knowledge you have for the social environment is from the town that you had live all your life.

The information that you have for the others in your town is a mix between how they act towards you and how you interpret their actions. If, for example, you are a postman and everybody is shouting at you and calling you names while you are doing your job, you may believe that all the others around you are savages and that you should better just leave the place and relocate in another area. Or you may believe that you are inadequate for this job and eventually find a new one. Thus, it is not just what the signal is but also what we understand from that. A cognitive bias now, is a false translation of these external  signals. The funny thing is that we all make the same mistakes in certain areas or to put it differently we misinterpret some things.

For example:

1    Gambler's fallacy: Imagine you go to a casino. You sit in a roulette table and you decide to play with the black and red color instead of the numbers. You find out that the last ten times it was the red color that has  appeared. What are you going to choose? Well, whatever you decide still falls in the 50% - 50% odds. The history of  the roulette does not give us any information for what it will come up this time. So, choosing the black color still gets you the same chances.

2     Hindsight bias: For me at least, it is quite common, that when an event of my life has finished it seems so obvious and predictable. Take for example, when you pass an important test. When you get your grade it seems so obvious that you would have that results. But that was not the case when you initially enrolled, was it?

      3.   IKEA effect: there are academic studies that show that things that we do / create  in our own, we tend to believe that they have higher value that they actually have. A research that has been carried out found that the price that one would want so as to sell an IKEA furniture that has assembled himself was considerable higher than what others were willing to pay for that piece of furniture.

In the following video, Dan Ariely is examining the IKEA effect using Origami creations.

P.S. Bias blind spot: The belief that one is less biased than all the other, or that one can identify more biases than the others.

Homer's rationality

Last year, that I have started studying for my PhD, the initial bibliography that I was reading was on strategic management and finance topics. In order for me to get the full picture of what I was reading I had to go back and start from the beginning  During the 70s and the 80s the main idea was that people in general, basically act in a rational way. 

Well, what does rationality mean then? On general terms,

it means that the average next door guy (take Home Simpson for example) 

will take every day decisions that will be for his best economic interest. So, when Homer decides what job he will do for a leaving or what kind of food he will eat 

or what kind of investment scheme he will go for, he must be thinking kind like a robot or like an excel 

spreadsheet. He must add up all the pros of a decision then add up all the cons of the decision, 

then think again about any potential alternatives and finally reach a point that he will be sure that he is getting the best of what he wants (food, car, house etc.) and on the same time he is paying the most reasonable price.

Let's assume for a while that this procedure, while it seems a bit long, does actually happens in our minds before we do or buy something. But do we always act in our best interest and try to be better off in money terms as it suggested? I mean we do also impulsive things right? I suspect you have found yourself in  a H&M or Top Shop store and you just picked up and bought a T-shirt just because you liked and the price was fair. You did not really think about the potential alternatives of all the other T-shirts that were sold in your area.

So does that make you irrational? Do we always act in our best economic interest?

Lately, there are quite a lot of scholars that started not to be so sure about how rational we act. Take for example finance. Dr. Barberis recently presented the idea that even when we consider the stock markets that so many smart guys work there we can actually find stupid behaviors, or to put it more gently, not so rational behaviors. The reason for that, is that all of us do have a personality that consists of positive and negative characteristics. We do not interact with the others just on numeric terms. We do have emotions and feelings that are interpreted in needs. Probably, we do try to be better off on a constant basis but not just through the maximization of our monetary profitability.

P.S. The video following is from Yoram Bauman (aka Stand - up economist). The guy is trying to interpret the 10 economic principles of Mankiw where rationality is included. I laughed quite a lot I have to admit. More of his videos can be found in http://standupeconomist.com/.

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