The Errors in Our Decision-Making - How to Estimate Odds and Values?
READING TIME: 6 MINUTES
We’re faced with different choices every day. We try to make rational decisions but we don’t always succeed. Harvard psychologist and author Dan Gilbert claims that our decision-making is often flawed because our understanding of the situation is susceptible to many factors.
In his TED talk, Dan Gilbert shows us how perceptions affect our thinking and reveals how to think more clearly about the choices that lie ahead.
Mathematical Formula for Decision-Making
Wouldn't it be great to have somebody who would always know the right thing to do and advise you? As it turns out, it's a gift that the world was already given back in 1738. Dutch scholar Daniel Bernoulli thought of a formula that can be used to calculate and predict the values of our decisions.
The English translation that captures the gist of Bernoulli’s formula is:
Expected Value = Odds of Gain x Value of Gain
The expected value of any of our actions refers to the goodness or benefits we can expect to get. It's a result of the odds of potential gain and the value of that gain to us. If we can adequately estimate and multiply these two parts of the equation, we would precisely know what actions to take and what decisions to make.
To better understand it, Gilbert shares a simple coin toss example. Let's imagine that if the coin toss comes up heads, the winning is $10. But, to play, one needs to pay $4. Is it worth it? According to Bernoulli's formula, the odds of winning are 50%, and the potential value is $5 because 50% of $10 is $5 (1/2 x $10 = $5). Most of us would take that bet because the odds of winning are high, and the expected value is more than $4 we had to pay at the beginning.
However, in real life, nothing is so black-and-white. We're more likely to make errors while estimating the odds that we're going to succeed and the values of that success.
Errors in Estimating Odds
When estimating odds, we need to ask ourselves - what are the chances something will happen?
The problem is, we often can’t estimate this probability correctly because we base our thinking on what we can easily imagine or what we’re familiar with.
For example, if asked - Are there more 4-letter English words with R in the 3rd place or 1st place? The most common answer would be the latter because words like 'ring, rang, rung,' first come to mind. But, the fact is, there are more English words with R in the 3rd place. We chose the wrong answer because it takes more effort to think of other words, such as 'bare, park, fort', and others.
Another good example is the conducted survey where the American citizens were asked about the most common cause of death. They tried to guess how many people die from drowning vs. tornadoes vs. asthma vs. firework accidents annually. Most people overestimated the big events, such as tornadoes and fireworks, and underestimated asthma and drowning.
The reason for this is media coverage. We often read about shocking stories and newsreels involving catastrophic weather events or New Year's accidents. Naturally, these instances would first come to mind when asked such a question. Still, in reality, deaths by drowning and asthma are much more common.
Finally, Dan takes the lottery as an ultimate example of people overestimating their odds for success. We can see on the news only the rare lottery winner interviews. Losers, on the other hand, are never interviewed as they're nothing new or interesting. This leads us to believe that the chances of winning the lottery are much higher than they actually are, and we often end up buying that lottery ticket.
Errors in Estimating Value
Trying to estimate how much something is worth or how much we’ll enjoy something is much harder than trying to estimate the odds.
The most common mistake when estimating value is our tendency to compare to the past. Many marketing agencies took advantage of this tendency and often play the popular ‘price cut’ tricks saying that something used to be more expensive. For consumers, ‘paying less’ for something is certainly a good deal.
If we assume that a $2000 Hawaiian vacation package is now on sale for $1600, most people will buy the new package. Let's imagine a different scenario where a $2000 package is on sale for $700, and you decide to think about it. One week later, the same package is now $1500. Most people wouldn't go for this deal, because they don't want to spend $1500 for something that used to be $700, even though the final price is still lower than in the first scenario. We tend to compare values and prices to what we know from the past, causing us to pass up a better deal.
Another mistake we make when estimating value is shifting comparisons. For example, we’re at a music store comparing two sets of speakers. You can’t help but feel how the bigger ones sound better than the smaller ones, and you end up buying them even though they were more expensive and don’t fit with your house decor. When playing them at home, however, you’ll never make that comparison again.
Once again, Gilbert shows how marketers take advantage of shifting comparison as well. Let's imagine we're at the wine store, and there are three bottles of wine on a shelf - one is $8, the one in the middle is $27, and then there's a $35 bottle. The majority of people would buy the mid-range wine. However, smart retailers will put another insanely expensive bottle of wine next to them, and suddenly the $35 bottle seems like a great deal. But, when drinking that wine at home, this comparison won't add to the value of us enjoying it. We will focus on the taste rather than the price we saw on that shelf.
Therefore, the problem of shifting comparisons arises when we make value comparisons based on the momentary context instead of future experiences.
How to Make Better Decisions?
To make better decisions, we need to minimize our errors in estimating odds and values. We can do this if we:
- Remove the confirmation biases from our decision-making process by questioning our assumptions and basing our beliefs on facts rather than emotions. Instead of responding to your gut feeling immediately, spend some time on research and gather more information before making a decision;
- Eliminate the momentary comparisons from the equation, and test the value against our experiences instead of immediate options at hand. For example, if you’ve always liked Pinot Grigio, don’t let the price tag convince you otherwise.
To make the best of Bernoulli's great gift, we need to better analyze our odds and be more rational when identifying the values of the present options.
We are the only species on this planet that has ever held its own fate in its hands…The only thing that can destroy us and doom us are our own decisions.
- Dan Gilbert
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