Sunday, February 26, 2012

Order Defined in the Process of Its Emergence

James Buchanan wrote among the best page in economic theory penned in the last 50 years in my opinion. As he explained:

I want to argue that the "order" of the market emerges only from the process of voluntary exchange among the participating individuals. The "order" is, itself, defined as the outcome of the process that generates it. The "it," the allocation-distribution result, does not, and cannot, exist independently of the trading process. Absent this process, there is and can be no "order."

Tuesday, February 21, 2012

Thinking Fast and Slow

Ongoing comments - Part 4 - Choices

Chapter 25 - Bernoulli's Errors.

Modified utility theory into prospect theory - great example - what would you chose toss a coin - win 100 dollars heads or 0 dollars tails or a sure thing - 46 dollars.

Bernoulli argues that diminishing marginal utility to wealth leads to risk aversion.

Flaw outlined with Jack and Jill example on page 275 is the reference point and expected utility lasted due to theory induced blindness.

Chapter 26 - Prospect Theory

Risk averse between good choices and risk seeking between bad choices. 280

System 1 282

Evaluation relative to a "neutral" reference point

Diminishing sensitivity

Loss aversion - see page 285

Chapter 27 - The Endowment Effect - American Pickers and the guy who had the peddle car. Trade a 57 t-bird for it, but would not accept a cash offer in excess. With Thaler used the Vernon Smith market experiment to look for endowment.

Indifference curves with Ben and Albert

Chapter 28 Bad Events

Very interesting chapter - negativity and escape dominate positivity and approach. Fight or flight and we tend to flee.

Bad dominates good - page 302 - stable relationship needs 5 times positive to negative interactions

Great example - gold and putting for par (avoid a bogey) v putting for birdie.

Chapter 29 - The Fourfold Pattern - great line - 310 - we are just an observer to a global evaluation that system 1 delivers
page 317

Chapter 30 - Rare Events

Over estimation and over weighting
Focused attention
confirmation bias
cognitive ease

Choice from experience and choice from description - Black Swans

Choice from experience in rare events (neglect) will be underweighted

Chapter 31 - Risk Policies

Chapter 32 - Keeping Score

Responsibility - losses weighted twice as gains in many contexts - choice between gambles, endowment effect, reactions to price changes.

Chapter 33 - Reversals

Preference reversal - value of a bet - 355. Issues of joint v single evaluation.

Chapter 34 - Frames and Realities

Neuroeconomics - page 366 How a choice is framed influences consideration, judgment and choice therefore "most of use accept decision problmes as they are framed and therefore rarely have an opportunity to discover the extent to which our preferences are frame bound rather than reality bound."(367). This is due to the fact that system 2 is lazy and system 1 moves intuitively and quickly and tends to accept questions as framed. Great example - Thomas Schelling and the rich/poor tax code decision - page 370.

Great framing example - Adam and Beth and the gas guzzler and efficient car - page 372. This is interesting - Nudge and Sunstein and Thaler.

Saturday, February 18, 2012

Thinking Fast and Slow

Ongoing comments - Part 3 - Overconfidence

Chapter 19 - The Illusion of Understanding.

Inability to reconstruct beliefs and past beliefs leads to hindsight bias, outcome bias which can and does lead to risk aversion and can increase the reputation of gamblers. The impact of luck tends to be underestimated in judgment and decision making.

Chapter 20 - The Illusion of Validity page 212 These are cognitive illusions such as the illusion of skill or validity and a nice illustration with stock pickers.
2 of these

Chapter 21 - Intutions v Formulas -

Page 224 "experts inferior to algorithims" example - page 226 marital stability is a function of frequency of lovemaking - frequency of quarrels" and . . . you don't want a negative number.

Chapter 22 Expert Intuiton: When can we Trust it?

Intuition as recognition - the firefighter example. The environment of skill and cognitive ease and coherence. (239)

Conditions to trust

environment that is regular and predictable
prolonged practice to learn the regularities

Chapter 23 - The Outside View - planning fallacy

Chapter 24 - The Engine of Capitalism

The role of confidence, the impact of overconfidence, the costs and benefits of overconfidence in the short and long run.

Friday, February 17, 2012

Thinking Fast and Slow

Ongoing comments - Part 2 - Heuristics and Biases

Chapter 10 - The Law of Small Numbers. Great point - page 115 "The widespread misunderstanding of randomness sometimes has sifnificant consequences." We seek patterns and, by looking a samples that are too small, may find meaning or explanations where none exist. A la the "hot hand" in basketball.

Chapter 11 - Anchors

2 of these

System 1 - anchoring that is automatic as a result of "priming"

System 2 - anchoring as adjustment

Interesting idea - anchoring index page 123 excellent set of examples of the anchoring effect as measured by the anchoring index in the real work - listing prices of homes, donations, and the terrifying example of dice and German judges on pages 125-6

Chapter 12 - The Science of Availability - page 131 married couples asked about contributions to housework - added answers are greater than 100 per cent.

Paradoxical results of availability research and self awareness.

Availability bias conditions (lead to increased bias)

engaged in an effortful task
good mood
low depression
knowledgable novice
high in faith in intuition
powerful or feel powerful

Chapter 13 Availability, Emotion and Risk

Activation of ideas in associative memory can lead to substitution therefore the following can impact system 1 judgments and lead to intuitve action

The media
Highlighted or bolded text
Pre existing feeling - affective heuristic

Experiment on associative coherence - technology survey - is technology, on net, positive or negative.

Slovic favors decentralized risk assessment and reaction, Cass Sunstein favors experts due to the availability cascade.

Chapter 14 - Tom W's Specialty - 9 majors in grad school, then description of Tom and rank each time.

page 151

Reader of NY Times on the New York Subway

No college degree

Rerun experiment - Harvard have 1/2 puff out cheek, 1/2 frown then answer. Frowners improved results.

Chapter 15 - Linda: Less is more

Chapter 16 - Causes Trmpt Statistics

Stereotyping - page 169

Chapter 17 - Regression to the Mean - page 181-182 The comment, in a trial, the side that must explain regression to a jury will lose. Mind biased toward causal explanations and does not process statistics.

Chapter 18 - Making Intuitive Predictions

Intuitive predictions - system 1
extreme predictions and rare events manifestions of system 1

Correcting or adjusting intuitive predictions - system 2

Both system 1 and 2 have a problem with regression

Thursday, February 16, 2012

Thinking Fast and Slow - Chapter 9

Chapter 9 Answering An Easy Question was, for me, the take away from the book.

Kahneman brings together systems 1 and 2 and a process that leads to both efficiency in decision making and potential bias in conclusions.

Substituting questions (97).

In an effort to address complex matters, Kahneman asserts we form intuitive opinions through the process of substitution. That is, system 1, confronted with a complex situation, finds a related, simplier question that is easier to answer.

This process is not conscious, rather it is "a consequence of the metal shotgun, the imprecise control we have over targeting our responses to questions."(98).

A key element of this process of answering an easier question is intensity matching.

Kaheman argues that mental shotgun and intensity matching are automatic processes that can lead to a true illusion, not a misunderstanding.

This leads to a dominance of conclusions over arguments, particularly when emotions are significant and present - see page 103.

Saturday, February 11, 2012

Thinking Fast and Slow

In anticipation of our Feb. 22, 2012 ASET book club, I will be blogging on our book - Thinking Fast and Slow. Today - Part 1 - Two Systems.

Chapter 1
- 2 systems lays out the framework for analysis in the book. Kahneman describes System 1 as the automatic, reflexive element of our thinking and System 2 is the reflective, critical element of thinking. I find this model useful as I ponder the often paradoxical behavior of us all in trying to understand the world through a set of beliefs. This first chapter shows the power of belief in fostering illusion - the famous Muller-Lyer illusion (2 identical lines with differing tails) are presented - our view of the world can and is shaped in ways that conflict with reality. I found the description of cognitive illusion helpful, and perhaps pessimistic, in thinking about the ability to move beyond belief in action. Kahneman correctly writes:

The premise of this book is that it is easier to recognize other people's mistakes than our own. (28)

Chapter 2 - Attention and Effort.

System 1 is characterized by intuitions and impulses and System 2 is the area of effort and self control. Page 35 is a great analogy of system 2 as a circuit breaker and attention/effort/energy is focused on the complex and critical cognitive effort - Attention and Effort was the author's book on cognitive pulillometry.

System 2 tasks

Simultaneously maintain in memory several ideas that require separate action.

Combinations that require rules

Switching from one task to another

Chapter 3 - The Lazy Controller. System 2 prefers automatic pilot work of System 1 to conserve energy and has a natural speed of work or effort that is preferred.

Self control and deliberate thought draw on a limited budget of effort.

System 1 has more influence when System 2 is busy.

Intelligence, control and rationality

Chapter 4 The Associative Machine

Responses that are associatively coherent. Hume

Contiguity in time and place

Banana Vomit

Associative thinking is subconscious, below our awareness.



is it soup or is is soap

Money as a primer - page 55

Chapter 5 - Cognitive Ease

Illusions of remembering (60)

Illusions of truth (61)

Chapter 6 Norms, Surprises, and Causes

Great line and Danny Kaye quote (79) A Machine for Jumping to Conclusions - system 1.

Believing is a system 1 activity, unbelieving is a system 2 activity. (81) Confirmation bias is deeply ingrained and it goes against nature to test a hypothesis by disproving rather than proving.

Key point - page 86 coherence seeking system 1 and lazy system 2 leads to system 2 endorsing intuitive beliefs.

Chapter 8 How Judgments Happen Key chapter on interaction between systems 1 and 2, the environment, and formation of judgments. Unconsciously we work to conserve cognitive effort and, using ease, repetition we develop a narrative or story (89) in system 1 intuitively.

Basic judgments - judge politicians - judgment heuristic to answer an easy question, not the hard one that misses the mark.

Chapter 9 Answering an easier question.

Friday, February 10, 2012

ASET Book Club

Join the Arizona Society of Economics Teachers Book Club to discuss Thinking, Fast and Slow by Daniel Kahneman on Wednesday, February 22, 2012. Please email for more information.

Date: February 22, 2012
Time: 5:45 - 7:45 p.m.

Arizona Council on Economic Education office
3260 North Hayden Road, Suite 207
Scottsdale, Arizona 85251

Excellent Reviews

Book Review: Thinking, Fast and Slow by Daniel Kahneman
A Nobel laureate’s new book cautions us not to trust our gut
By Roger Lowenstein

Thinking, Fast and Slow, Kahneman’s new and most accessible book, contains much that is familiar to those who have followed this debate within the world of economics, but it also has a lot to say about how we think, react, and reach—rather, jump to—conclusions in all spheres. What most interests Kahneman are the predictable ways that errors of judgment occur.

Synthesizing decades of his research, as well as that of colleagues, Kahneman lays out an architecture of human decision-making—a map of the mind that resembles a finely tuned machine with, alas, some notable trapdoors and faulty wiring.

New York Times Review

System 2, in Kahneman’s scheme, is our slow, deliberate, analytical and consciously effortful mode of reasoning about the world. System 1, by contrast, is our fast, automatic, intuitive and largely unconscious mode. It is System 1 that detects hostility in a voice and effortlessly completes the phrase “bread and. . . . ” It is System 2 that swings into action when we have to fill out a tax form or park a car in a narrow space. (As Kahneman and others have found, there is an easy way to tell how engaged a person’s System 2 is during a task: just look into his or her eyes and note how dilated the pupils are.)

More generally, System 1 uses association and metaphor to produce a quick and dirty draft of reality, which System 2 draws on to arrive at explicit beliefs and reasoned choices. System 1 proposes, System 2 disposes. So System 2 would seem to be the boss, right? In principle, yes. But System 2, in addition to being more deliberate and rational, is also lazy. And it tires easily. (The vogue term for this is “ego depletion.”) Too often, instead of slowing things down and analyzing them, System 2 is content to accept the easy but unreliable story about the world that System 1 feeds to it. “Although System 2 believes itself to be where the action is,” Kahneman writes, “the automatic System 1 is the hero of this book.” System 2 is especially quiescent, it seems, when your mood is a happy one.

Review of Thinking, Fast and Slow by Daniel Kahneman
By Max H. Bazerman

Do cognitive biases show up in people other than college sophomores? Do people make decision mistakes outside the lab, when real incentives are on the line? Are smart people immune from bias? Are these biases really mistakes? Does experience eliminate biases?

As a card-carrying member of the biases-and-heuristics crowd of the behavioral decision research field, these are the questions I have continually been asked over the years, despite my belief that they were answered conclusively long ago. In accepting an invitation to review Thinking, Fast and Slow (TFS) by Daniel (Danny) Kahneman, I anticipated getting a comprehensive and clear response to these decades-old questions. Instead, TFS provides an assessment and integration that goes far beyond these early, comparatively simple questions.

Financial Times Review

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Kahneman presents our thinking process as consisting of two systems. System 1 (Thinking Fast) is unconscious, intuitive and effort-free. System 2 (Thinking Slow) is conscious, uses deductive reasoning and is an awful lot of work. System 2 likes to think it is in charge but it’s really the irrepressible System 1 that runs the show. There is simply too much going on in our lives for System 2 to analyse everything. System 2 has to pick its moments with care; it is “lazy” out of necessity.

Books on this subject tend to emphasise the failings of System 1 intuition, creating an impression of vast human irrationality. Kahneman dislikes the word “irrationality” and one of the signal strengths of Thinking, Fast and Slow is to combine the positive and negative views of intuition into one coherent story. In Kahneman’s words, System 1 is “indeed the origin of much that we do wrong” but it is critical to understand that “it is also the origin of most of what we do right – which is most of what we do”.

Wall Street Journal

Slate Magazine

Sunday, February 5, 2012

2012 ASET Conference

11th Annual ASET Conference
Making ₵ents of the ₵entennial

Conference Schedule At-A-Glance
Feb. 4, 2012

8:30 - 9:00 Registration & Continental Breakfast
Downstairs, Library Corridor

9:00 - 9:15 Welcome & Introductions
SW Reading Room, 3rd Floor

9:15 - 9:20 An Economics “Short”: Economics of a Zombie Attack – Scott Gustafson, Mesa Community College

9:20 – 10:05 Keynote Speaker – Jim Rounds, Sr. Vice President, Sr. Economist, Elliott D. Pollack & Co.

10:05 - 10:25 Break (Visit Exhibitors for extra door-prize tickets!)

10:25 – 11:15 Break-out Session 1 - AS Classrooms

11:15 - 12:15 Lunch & Exhibitors
Lunch served downstairs, Library Corridor
Seating on 3rd floor balconies and Library Corridor

12:15 - 12:30 Presentation of Award Recipients & ASET Board Members & Candidates
SW Reading Room, 3rd Floor

12:30 – 1:15 Keynote Speaker - Cynthia Course, San Francisco Federal Reserve Bank

1:15 - 1:35 Break (Visit Exhibitors for extra door-prize tickets!)

1:35 - 2:25 Break-out Session 2 – AS Classrooms

2:30 – 3:00 Door Prizes, Ballots, Evaluations, Certificates
LB 145, Library Classroom, 1st Floor