This post is also available in: Italiano
Corporate Management and Self-Management
Faculty of Social Sciences at the University of Trent; October 13, 2018. “Common Mistakes in Daily Decisions – from Misunderstandings to Reality”. Lecture by Magalì Fia (part 1). See Part 2.
This is not an economics class. It’s a reflection that aims to bring some economic principles to the topic proposed by Osservatorio Interiore: common mistakes in daily decisions.
There are two ways of interpreting situations: one is rushed and superficial, the other is thorough and investigated. Mental strategy and shortcuts are sometimes useful, but economics offers a more in-depth interpretation of situations.
Many economists have studied how people decide. The Neoclassical Paradigm in Economics (which occupied the entire 20th century) assumes that individuals can foresee all the workable alternatives and consequences of a choice and therefore decide in order to achieve maximum satisfaction. However, many scholars offer different explanations of individual behavior.
Herbert Simon (Nobel Laureate in Economics in 1978 ‘for his pioneering research on decision-making in economic policies’) advanced the concept of limited rationality. We have a limited mental capacity for calculating all the workable alternatives. In addition, the information available is limited and costly.
For instance, if I want to buy a used car, I can’t screen all the used cars in the world and do a complete ranking. It would be too expensive, and I could not calculate all the alternatives. I will stop within reason when I find a car that meets my needs.
Kahneman and his colleague, Tversky, showed that people adopt unconscious, automatic mechanisms: so-called heuristics or “mental shortcuts” mainly in order to reach quick effective decisions. But these can lead to systematic errors (called bias). If I have enough time, I can test more in-depth alternatives.
Because of their fast nature, automatic mechanisms do not bring about thorough, well thought out decisions within a specific context and a goal.
Let’s see how to make better informed decisions for better self-management. Clinging to a decision (regardless of the consequences) leads to diseconomies. Here are some examples:
Examples of self-management (common mistakes in daily decisions)
I need to go shopping and the supermarket is two miles away. After walking for one mile, I remember the supermarket is closed. What should I do?
- I can keep going for the remaining mile since I have already walked one mile and I don’t want to waste the effort already made.
- I can go home and spend that time on something else.
- To keep going would be a silly choice (unless one of my goals was to exercise).
But not all choices are intuitive. In that case, we ask ourselves:
What is my goal? What are the alternatives?
We often have to face-up to the consequences of choices based on “MAYBE”. Maybe things will change. Maybe my investment will become profitable.
We sometimes keep going with our projects, even if, at some point, we realize that the probability of failure is very high. We think: “maybe … things will change and the company will succeed after all”. Because of “MAYBE” we risk incurring high costs.
Here is another example. I’ve invested time and money in my career as a teacher. After 10 years, I realize I would be better off elsewhere, perhaps in the restaurant business. I can use the following logic: “I have already invested 10 years and I don’t want to waste my investment. I don’t want to see my investment thrown away”. But, if that path doesn’t make me feel fulfilled, should I continue without considering the alternatives? People often say, “MAYBE it’s not that bad, MAYBE I’ll learn to like it, after all.”
The cost of MAYBE is tied to expectations. Economic principles allow me to clarify the situation regardless of right or wrong considerations.
See other pages by Magalì Fia: