Thanks Keith, Always glad to have your help.
REH ----- Original Message ----- From: "Keith Hudson" <[EMAIL PROTECTED]> To: "Ray Evans Harrell" <[EMAIL PROTECTED]> Cc: <[EMAIL PROTECTED]> Sent: Tuesday, November 05, 2002 3:29 PM Subject: Re: A more rational economics > Ray, > > Thank you for posting such an excellent article from today's NYT. (I've > re-formatted it below for the benefit of those who might like a little more > spacing.) > > Keith > > <<<< > ON PROFIT, LOSS AND THE MYSTERIES OF THE MIND > > By Erica Goode > > > "Kahnemanandtversky." > > Everybody said it that way. > > As if the Israeli psychologists Daniel Kahneman and Amos Tversky were a > single person, and their work, which challenged long-held views of how > people formed judgments and made choices, was the product of a single mind. > > Last month, Dr. Kahneman, a professor at Princeton, was awarded the Nobel > in economics science, sharing the prize with Vernon L. Smith of George > Mason University. But Dr. Kahneman said the Nobel, which the committee does > not award posthumously, belongs equally to Dr. Tversky, who died of cancer > in 1996 at 59. > > "I feel it is a joint prize," Dr. Kahneman, 68, said. "We were twinned for > more than a decade." > > In Jerusalem, where their collaboration began in 1969, the two were > inseparable, strolling on the grounds of Hebrew University or sitting at a > cafe or drinking instant coffee in their shared office at the Van Leer > Jerusalem Institute and talking, always talking. Later, when Dr. Tversky > was teaching at Stanford and Dr. Kahneman at the University of British > Columbia, they would call each other several times a day. > > Every word of their papers, now classics studied by every graduate student > in psychology or economics, was debated until "a perfect consensus" was > reached. To decide who would appear as first author, they flipped a coin. > > Wiry, charismatic, fizzing with intelligence, Dr. Tversky was younger by a > few years. Dr. Kahneman, as intellectually keen, was gentler, more > intuitive, more awkward. > > Together, the psychologists developed a new understanding of judgments and > decisions made under conditions of risk or uncertainty. > > Economists had long assumed that beliefs and decisions conformed to logical > rules. They based their theories on an ideal world where people acted as > "rational agents," exploiting any opportunity to increase their pleasure or > benefit. > > But Dr. Kahneman and Dr. Tversky demonstrated that in some cases people > behaved illogically, their choices and judgments impossible to reconcile > with a rational model. These departures from rationality, the psychologists > showed, followed systematic patterns. > > For example, the exact same choice presented or "framed" in different ways > could elicit different decisions, a finding that traditional economic > theory could not explain. > > In an oft-cited experiment, the psychologists asked a group of subjects to > imagine the outbreak of an unusual disease, expected to kill 600 people, > and to choose between two public health programs to combat it. > > Program A, the subjects were told, had a 100 percent chance of saving 200 > lives. Program B had a one-third chance of saving 600 lives and a > two-thirds probability of saving no lives. > > Offered this choice, most of the subjects preferred certainty, selecting > Program A. > > But when the identical outcomes were framed in terms of lives lost, the > subjects behaved differently. Informed that if Program A were adopted, 400 > people would die, while Program B carried a one-third probability that no > one would die and a two-thirds probability that 600 people would die, most > subjects chose the less-certain alternative. > > Over more than two decades, working together or with others, Dr. Kahneman > and Dr. Tversky elaborated many situations in which such psychological > "myopia" influenced people's behavior and offered formal theories to > account for them. > > They established, among other things, that losses loom larger than gains, > that first impressions shape subsequent judgments, that vivid examples > carry more weight in decision making than more abstract - but more accurate > - information. > > Anyone who read their work, illustrated, as one admirer put it, with > "simple examples of irresistible force and clarity," was drawn to their > conclusions. > > Even economists, unused to looking to psychology for instruction, began to > take notice, their attention attracted by two papers, one published in 1974 > in Science, the other in 1979 in the economics journal Econometrica. > Eventually, the psychologists' work provided the undergirding for > behavioral economics, the approach developed by Dr. Richard Thaler. > > In a recent conversation, Dr. Kahneman, who carries both American and > Israeli citizenship, talked about what happens when psychology and > economics meet. > > Q. Did you set out to challenge the way economists were thinking? > A. We certainly didn't have in mind to influence economics. > > In the first years, economists, and philosophers, too, were simply not > interested in the trivial errors that we as psychologists were studying. > > I have a clear memory of a party in Jerusalem around 1971, attended by a > famous American philosopher. Someone introduced us and suggested that I had > an interesting story to tell him about our research. He listened to me for > about 30 seconds, then cut me off abruptly, saying, "I am not really > interested in the psychology of stupidity." > > Our work was completely ignored until our 1974 paper, which eventually had > an impact on both economics and epistemology. Of course, we did not mind in > the least because economists were not our intended audience anyway; we were > talking to psychologists. It came as a pleasant surprise when others > started to pay attention. > Q. Why is the rational model of human behavior so entrenched in economic > theory? > A. There's a very good reason for why economics developed the way it did, > and that is that in many situations, the assumption that people will > exploit the opportunities available to them is very plausible, and it > simplifies the analysis of how markets will behave. > > You know, when you're thinking of two stalls next to each other selling > apples at different prices, then you're assuming that the fellow who is > selling them at too high a price is just not going to have customers. > > So you get rationality at this level, and it buys a lot of predictive power > by this assumption. When you are building a formal theory, you want to > generalize that assumption, and then you end up making people completely > rational. > Q. You and Amos Tversky are perhaps best known for prospect theory. Could > you explain what this is based on? > A. When I teach it, I go back to 1738. In 1738, Daniel Bernoulli wrote the > big essay that introduced utility theory. Utility really means pleasure > more than anything else. > > The question that Bernoulli put to himself was "How do people make risky > decisions?" And he analyzed really quite a nice problem: a merchant > thinking of sending a ship from Amsterdam to St. Petersburg at a time of > year when there would be a 5 percent probability of the ship being lost. > > Bernoulli evaluated the possible outcomes in terms of their utility. What > he said is that the merchant thinks in terms of his states of wealth: how > much he will have if the ship gets there, if the ship doesn't get there, if > he buys insurance, if he doesn't buy insurance. > > And now it turns out that Bernoulli made a mistake; in some sense it was a > bewildering error to have made. For Bernoulli, the state of wealth is the > total amount you've got, and you will have the same preference whether you > start out owning a million dollars or a half million or two million. But > the mistake is that no merchant would think that way, in terms of states of > wealth. Like anybody else, he would think in terms of gains and losses. > > That's really a very simple insight but it turns out to be the insight that > made the big difference. Because, if that's not the way that people think, > if people actually think in terms of gains and losses and not in terms of > states of wealth, then all the mathematical analysis that has been done > which assumed people do it that way is not true. It took us a long time to > figure it out. > Q. What kinds of things does prospect theory explain? > A. I think the major phenomenon we observed is what we called "loss > aversion." There is an asymmetry between gains and losses, and it really is > very dramatic and very easy to see. In my classes, I say: "I'm going to > toss a coin, and if it's tails, you lose $10. How much would you have to > gain on winning in order for this gamble to be acceptable to you?" > > People want more than $20 before it is acceptable. And now I've been doing > the same thing with executives or very rich people, asking about tossing a > coin and losing $10,000 if it's tails. And they want $20,000 before they'll > take the gamble. > > So the function for gains and losses is sort of kinked. People really > discriminate sharply between gaining and losing and they don't like losing. > Q. How did prospect theory influence economists? > A. Correcting Bernoulli's error was influential, because it was picked up > by Richard Thaler, who started behavioral economics. We provided cover for > behavioral economics, because the challenge to the rational model was taken > seriously and presented in a way that readers of the work found compelling. > > But it's not as if this has swept economics. It hasn't, and for very deep > structural reasons, it's not going to. The rational model has a hold on > economics, and it's going to stay that way. Behavioral economists fiddle > with it, improving the assumptions and making them psychologically > sensible. But it's not a completely different way of doing economic theory. > Q. One of the things you are studying now is well-being. Does this connect > in any way to economics? > A. I would like to develop a measure of well-being that economists would > take seriously, an alternative to the standard measure of quality of life. > > We're attempting to measure it not by asking people, but by actually trying > to measure the quality of their daily lives. For example, we are studying > one day in the lives of 1,000 working women in Texas. We have people > reconstruct the day in successive episodes, as recalled a day later, and we > have a technique that recovers the emotions and the feelings. We know who > they were with and what they were doing. They also tell us how satisfied > they are with various aspects of their lives. We know a lot about these > ladies. > Q. What are you finding out? > A. I'll give you a striking finding. Divorced women, compared to married > women, are less satisfied with their lives, which is not surprising. But > they're actually more cheerful, when you look at the average mood they're > in in the course of the day. The other thing is the huge importance of > friends. People are really happier with friends than they are with their > families or their spouse or their child. > > Q. Why would divorced women be more cheerful? > A. So far, I don't understand it, but that's what the data says. > >>>> > > > > > -------------------------------------------------------------------------- -- > -------------- > Keith Hudson,6 Upper Camden Place, Bath BA1 5HX, England > Tel:01225 312622/444881; Fax:01225 447727; E-mail: [EMAIL PROTECTED] > ________________________________________________________________________
