Behavioral Economics Puzzles: Kahneman and Tversky's Experiments
In the December issue of the Journal of Economic Literature, RSF author Andrei Shleifer discusses the insights and ideas from Daniel Kahneman's latest book, Thinking, Fast and Slow. Published in 2011, the book summarizes Kahneman's innovative research on decision-making and human rationality; his work with Amos Tversky is widely believed to have played a pivotal role in the rise of behavioral economics. "The broad theme of [Kahneman and Tversky's work] is that human beings are intuitive thinkers and that human intuition is imperfect," Shleifer writes, "with the result that judgments and choices often deviate substantially from the predictions of normative statistical and economic models." He then summarizes prospect theory, heuristics, biases such as loss aversion, and possible future paths for behavioral economics, a relatively novel field that the Russell Sage Foundation has sponsored for more than two decades.
Shleifer also highlights some of Kahneman and Tversky's path-breaking questions and experiments that show part of the human mind to be "nonstatistical, gullible, and heuristic." Try the following puzzle:
An individual has been described by a neighbor as follows: “Steve is very shy and withdrawn, invariably helpful but with very little interest in people or in the world of reality. A meek and tidy soul, he has a need for order and structure, and a passion for detail.” Is Steve more likely to be a librarian or a farmer?
Shleifer explains the results:
Most people reply quickly that Steve is more likely to be a librarian than a farmer. This is surely because Steve resembles a librarian more than a farmer, and associative
memory quickly creates a picture of Steve in our minds that is very librarian-like. What we do not think of in answering the question is that there are five times as many farmers as librarians in the United States, and that the ratio of male farmers to male librarians is even higher (this certainly did not occur to me when I first read the question many years ago, and does not even occur to me now as I reread it, unless I force myself to remember). The base rates simply do not come to mind and thus prevent an accurate computation and answer, namely that Steve is more likely to be a farmer.
Another celebrated experiment, which Kahneman calls his "most controversial," is known as the 'Linda problem':
Linda is thirty-one 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...The respondents are asked to rank in order of likelihood various scenarios: Linda is (1) an elementary school teacher, (2) active in the feminist movement, (3) a bank teller, (4) an insurance salesperson, or (5) a bank teller also active in the feminist movement.
Again, here's Shleifer:
The remarkable finding is that (now generations of) respondents deem scenario (5) more likely than scenario (3), even though (5) is a special case of (3). The finding thus violates the most basic laws of probability theory. Not only do many students get the Linda problem wrong, but some object, sometimes passionately, after the correct answer is explained.
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