Tag Archives: loss aversion

Adaptively Rational.

In an economically rational world, individuals will maximize personal advantage by carefully weighing the costs and benefits of each of their decisions. Yet research in Behavioural Economics (BE) and Social Cognition has shown that people often make decisions that violate the axioms and models of standard economic theory- we choose immediate, smaller rewards over waiting for larger ones, we engage in behaviour that is damaging to health such as smoking and binge drinking and in general, we behave in ways that are seemingly against our own self interests. This evidence has led to the belief that human beings are irrational decision makers – and this irrationality can have economic, personal and social costs.

Irrationality, bias, fallacy- these have clear negative connotations. Often found to be the reason why we don’t take our medication, drink and drive, shop excessively and buy unhealthy food items in the supermarket, they form a part of our cognition that many wouldn’t particularly brag about. However despite being victims of these woeful biases and blunders, human beings have evolved to adapt, survive and reproduce. Our survival is dependent on the decisions we make and from an evolutionary perspective, some of our seeimingly irrational biases are actually rooted in rationality, for they have enabled the human species to survive in a world that can be fierce, competitive and dangerous. For example, let’s consider one of the most commonly cited concepts in behavioural economics – loss aversion, which is the tendency of individuals to prefer avoiding losses to acquiring gains of equal magnitude (e.g. Kahneman, 2011). While loss aversion has been demonstrated to be a contributing source to many of our sub-optimal decisions in the modern world, loss aversion effects have recently been found to be domain specific, with loss aversion being adaptive in the context of self protection. When our environment is threatening or fearful, being loss averse makes more adaptive sense than being gain focused (Li, Kenrick & colleagues, 2012).  Similarly, the in group  bias- the tendency to favour ones ‘in group’ has its evolutionary advantages- favouring your partner’s wellbeing over others’ leads to reproductive success (Haselton et al., 2009). ‘Motivated reasoning’ – our tendency to engage in selective recall that suits our current situation, can be highly adaptive in the domain of performance and persistence (Nettle, 2004). When studying for a final exam, recalling the previous times you were rewarded for studying hard is more likely to motivate you work hard again, compared to thinking about the times you tried and failed.

Fast and frugal heuristics-

Linda is 31 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 is more probable?

  1. Linda is a bank teller.
  2. Linda is a bank teller and is active in the feminist movement.

90% of those asked this question in a famous study by Kahneman and Tversky, chose option 2. This answer violates the logic of probability, because when you specify a possible event in greater detail (such as in example 2), you lower its probability (Kahneman, 2011). Yet people tend to choose option two because it seems more ‘representative’ of Linda. Here, people are using a heuristic. Heuristics are simple rules of thumb that are typically used when individuals have limited information or cognitive ability to engage in complex decision making. They have been found to be the cause of many of our sub-optimal decisions.

Heuristics are an important topic of study in the area of Bounded Rationality, which proposes that human decisions are limited by cognitive and time constraints. A group of researchers (e.g. Gigerenzer, Reimer & Reiskamp etc.) argue that as we cannot possibly know everything about the world we live in, our decision making environment favours bounded rationality. Therefore in this case, cognitive shortcuts can help us make more accurate decisions. Gigerenzer (2000) claims that heuristics are fast and frugal- they are simple and require little information, and this is often sufficient to make good decisions in an uncertain environment. For example, when information is limited, individuals sometimes rely on memory to make inferences about a criterion. In this case they use what is known as a ‘recognition heuristic’. Gigerenzer and colleagues posit that this heuristic is simple, economical and adaptive. A famous study by Goldstein & Gigerenzer (2002) in support of this claim showed that when American and German students were asked which city had a greater population- San Antonio or San Diego, German students were more likely to answer correctly-San Diego. This was because German students were likely to be more familiar with San Diego (compared to American students, who were equally familiar with both) and could use the recognition heuristic in this case.  Here, ignorance seems to be bliss indeed, as the heuristic aids information search for the German students accurately…as they are more familiar with San Diego, they choose it (the heuristic is also famously known as the less is more heuristic).

This research throws light on the importance of Ecological Rationality, which emphasizes understanding the context in which decisions are made before labelling behaviour as irrational. This has important implications for designing behaviour change interventions, with the key lesson being that biases that appear irrational in one context can be perfectly rational in another. On that note, here’s to looking back at all our years preceding 2014 with rosy retrospection 🙂

References-

Goldstein & Gigerenzer (2002) Models of Ecological Rationality : The recognition heuristic. Psychological Review,109.

Haselton et al (2009) Adaptive rationality- an evolutionary perspective on cognitive bias. Social Cognition, 274.

Li, Kenrick, Griskevicius & Neuberg (2012) Economic Decision Biases and Fundamental Motivations: How Mating and Self-Protection Alter Loss Aversion

Kahneman (2011) Thinking, fast and slow.