The art of rational thinking
Many scientists believe humans to be rational, reasonable beings. However, in recent years, this assumption has been criticized increasingly. In 2002, psychologist Daniel Kahnemann received the Nobel Prize in Economics as he was able to prove that oftentimes, humans don't act rationally, but are rather guided by irrational desicion making [1; 2].
Human error in reasoning
Daniel Kahnemann is of the opinion that humans use several rules of thumb - so-called heuristics - to simplify our life. We like comfort and convenience and it is far more convenient to use these heuristics as guidance, even if they might come with a price. Psychological research has identified three particularly serious human errors in reasoning, which we will explain in the following:
We find it difficult to assess possibilities. Instead of thoroughly considering the possible occurence of certain situations, we prefer to draw the conclusion that the easier it is for us to remember a certain information, the more often this information occurs. Thus, we think that a memory that we remember easily is more likely to occur. This has wide-ranging implications for us, as the following example demonstrates: Central Europe experiences devastating floods on a regular basis, that cause severe damage. Imagine you have to get an insurance for your house or apartment right after a flood occured. If the question arises of whether to get a flood insurence as well, you will be more likely to believe you need one as you will have just experienced a flood and therefore, your assessment of a possible flood occurence will most likely be too high.
We have different ideas of how supply and demand are connected to each other. For example, we tend to assume that products that are scarce are also valuable - which in most cases, is a fair assumption. The problem is, however, that we have fully internalized this assumption. As a result, this is enough to lead us to believe that just because a product is pricey, it has to be scarce. We will automatically consider this assumption to be true and be more willing to buy it. Many advertisers use this trick for their product: they tell us a product is very popular and almost sold out, which creates the illusion in us that it will be gone unless we buy it immediately. Another similar trick that is used to fool us is the price-quality-illusion: we assume that a product is expensive as it has a higher demand and therefore, it has to be very valuable. In order to avoid being fooled, we should pay attention to studies that examine the exact relationship between price and quality and consistently point out that there is almost no correlation between the two - a high price doesn't automatically guarantee good quality and a low price is not necessarily an indicator for low qualtity.
From an economical perspective, the price of a product is equal to its actual value. However, in psychological economics, it was shown that a price can be subjective or objective and that there is a difference between the two. The Nobel Prize Winner Daniel Kahnemann demonstrated in his research that the subjective positive value of a positive monetary amount x is smaller than the subjective negative value of a negative monetary amount -x. This may sound a little complicated, but in simple words: the prospect of winning 100 Euro excites us less than the prospect of loosing 100 Euro saddens us. What this means is that our fear of loss is disproportionately high.
Against this background, it becomes clear why we often purchase insurances we don't actually need, such as insurances for our smart phones or computers. If you look at it rationally, it doesn't make much sense to purchase an insurance for something with relatively low value. The next time you feel like purchasing an insurance, ask yourself if a potential loss would be as severe as you think and what the actual possibility of damage is.
Renaissance of heuristics
Heuristics have had to endure criticism for many years but it seems as if a more favourable trend is developing that highlights the positive characteristics of heuristics. In his research, the German psychologist Gerd Gigerenzer demonstrates the importance of heuristics as they significantly simplify our life. However, even if these heuristics can be very convenient for us and relieve us from at least some of our decisions, we should not trust them blindly as - like everything in life - even heuristics aren't perfect.Start training
1: Kahneman, D., & Tversky, A. (1979). Prospect Theory: An Analysis of Decision under Risk. Econometrica, 47(2), 263-291.
2: Kahneman, D., Slovic, P., & Tversky, A. (1982) Judgment Under Uncertainty: Heuristics and Biases. New York: Cambridge University Press.