The bestselling book ‘Thinking, fast and slow’ by Daniel Kahneman is, as it already says on the cover, ‘a lifetime’s worth of wisdom’. Therefore it is so full with knowledge that it is impossible to summarize it in a few hundred words. I highly recommend everyone who is even remotely interested in human behavior and why we do what we do to go buy the book himself. You won’t regret it. But in the meantime, I will give a short overview on what to expect.
PART 1: Two systems
The human brain works with two systems, which work very differently. While these systems don’t exist literally, they are a helpful way to describe how humans think.
System 1 works automatically and effortlessly, with little thinking, no sense of voluntary control, and little effort.
System 2 on the other hand does the slow thinking, mental work, concentration, choice and can construct thoughts in orderly steps. You cannot do several of these ‘system 2 activities’ at the same time.
System 1 is always active, while system 2 is usually on stand-by. It is only activated when system 1 needs support from system 2. Then however system 1 is overruled by decisions that are made by system 2, so system 2 has the last word. The cooperation of the two systems minimizes effort and maximizes results, since system 1 does most of the thinking and allows us to master our daily life (making coffee, tying shoelaces, driving cars) without having to focus too much on these activities.
While this division of labor between the two systems obviously has many benefits, it also leads to misjudgments of certain tasks when we let our system 1 solve problems that are too complex and should rather be solved by system 2. In these complex questions system 1 too often relies on the best possible approximation that is available, but often insufficient.
In an experiment people were asked how happy they are with their lives (a complex question that demands quite a bit of thinking). If right before that they were asked how many dates they had in the last month, system 1 uses a substitution heuristic and bases the answer of how happy you are on the answer you gave on how many dates you had! It is just a short time span and just one area of life, but since system 1 tells you that this is relevant information, system 2 will not even be activated to evaluate your life more carefully.
PART 2: Heuristics and biases
System 1 uses shortcuts to facilitate our brain’s work when we try to make estimations. Usually this works very well, but these estimations can also be misguided through a variety of heuristics and biases. Here just two of the most common ones as example.
Anchoring puts a number in your head when having to guess something. From there you assess whether it is too high or too low and gradually adjust your estimate to that anchor. The adjustment normally stops prematurely because people stop when they are no longer certain.
Consider this question:
“Was Gandhi 144 years old when he died?”
You know he wasn’t 144 when he died, but with this number in mind you are highly likely to give an older age as answer than someone who was asked “Was Gandhi 54 when he died?”
Anchoring is often used in negotiations, for example about the appropriate buying price for a product or when discussing the salary at a new job.
We tend to take more seriously what we are confronted with more (Daniel Kahneman calls this ‘What you see is all there is’). This leads to an overestimation of probabilities. A common example for that is that people are more scared of flying, even though a lot more people die in car accidents than in plane crashes. This is due to the fact that there is a lot more news coverage on plane crashes (and those look a lot more dramatic) than on car accidents. Hence information about plane crashes is more ‘available’ to our brain.
PART 3: Overconfidence
Basically everyone who has worked long enough in a certain profession develops confidence when asked to make predictions about future outcomes in his field of expertise. May it be doctors predicting how an illness will further develop, stock brokers predicting the stock prices for next year or political experts predicting the results of the upcoming election. It turns out however that many of these people are vastly overconfident!
The best example for that is in fact the stock market. As a market, it needs both buyers and sellers. You buy a stock if you think its price will go up and sell a stock if you think its price will go down in the future. Isn’t it odd though that experts, professional traders, look at the same stocks around the world and some decide to buy it while others decide to sell it? Both the buyer and the seller is certain that he is skilled enough to predict the future development of the stock price, but only one of them can be right.
Furthermore, the one who turns out to be right is usually just right by chance. He is likely to get it wrong the next time! Kahneman claims that the entire financial industry is an industry largely built around the illusion of skill. When analyzing the facts and data however (which Kahneman did) it turns out that on average stock brokers are not better at picking stocks than someone would be who simply roles a dice.
What’s worse is that these experts are not able to see their shortcoming, mostly due to the hindsight bias. Everything makes sense in hindsight and can be logically explained. Every stock broker can explain to you at the end of the day why the index went up or down. But if you had asked them at the beginning of the day, half of them would have sworn that the index will go up, while the other half would have been sure that the index will go down.
Similar overconfidence takes place when planning complex long-term projects. When estimating how long it will take or how much it will cost to finish the project, people tend to ignore the baseline prediction (an estimation based on the average of comparable projects in the past) and instead focus too much on the information they have about their individual case. This leads to something called the planning fallacy, which are forecasts that are unrealistically close to best-case scenarios and could easily be improved by consulting the statistics of similar cases.
Funny enough though this overconfidence often is the reason that things get done in the first place. If people knew from the start how much time, effort, and money it will cost to complete certain projects, they most likely wouldn’t start in the first place. So not knowing the odds that you are facing can be a good thing after all.
PART 4: Choices
In its fourth part, the book covers how humans make choices. For the longest time, Bernoulli’s utility theory was the dominant theory in this area, which claims that humans assign utilities to their possessions as well as their free time and their experiences and that they are indifferent between two objects with the same utility (which lie on the same utility curve). This theory however neglects the importance of reference points, as Daniel Kahneman pointed out. While 3000 Euro might always have the same objective utility, it feels completely different to someone who starts out at 0 and gains 3000 Euro than to someone who starts at 5000 Euro and loses 2000 of it. The reference points are different and that makes all the difference. This is called prospect theory.
An important part of prospect theory is the fact that most people are loss averse and therefore for them losses loom larger than gains, which means that losing an amount of money feels a lot worse to them than gaining the same amount feels good. (I talk about that in more detail in this video)
Another effect that influences the choices we make and that partly explains loss aversion is the endowment effect. This effect describes the fact that we value more what we own than what we don’t own. This is why most people are not willing to resell something for the same price they bought it for, even if it was just a few moments ago! If you just bought a bottle of wine for 20 Euros, but are not willing to resell it for the same price to a friend, you experience the endowment effect at work. It proves again how difficult it is to assign values/utilities to objects.
PART 5: Two selves
The human mind has two selves, the experiencing self and the remembering self. The experiencing self is at work while we are experiencing something. It judges the situation we find ourselves in in that particular moment. The remembering self on the other hand judges experiences as a whole and has a lot more influence on how we keep an experience in mind.
Since the remembering self overestimates the importance of recent events, the memory of an overall pleasant experience can be ruined if the end of that experience was unpleasant. This is can be true for a nice vacation when on the last day you get robbed as well as for a twenty year-long harmonic marriage if it ends in a nasty divorce.
People even make completely irrational decisions as soon as their remembering self takes over! In an experiment one group of people had to put their hands in ice-cold water for 60 seconds and was then allowed to take them out again. The other group had the same task, but after 60 seconds they had to leave the hands in for another 30 seconds, during which the temperature of the water was increased by about 1 degree (just enough to notice it).
Then the two groups were asked which set-up they would like to repeat once more. Unsurprisingly, the 60-second group wanted to repeat that one again. But the 90-seconds group also wanted to repeat ‘their’ setup again, instead of switching to only 60 seconds of pain!
So they willingly accepted an extra and completely unnecessary 30 seconds of pain, simply because in their memory it felt a little less bad. Their remembering self tricked them!
The whole book is about how we are influenced by heuristics, biases, fallacies and such. They can lead to misjudgments of our surroundings and the world we live in. This is only a tiny fraction of the thousands of judgments we make each day though, and usually our brain is amazingly good at making accurate decisions in fractions of a second and with the least amount of effort.