Think outside the Brain
You are on a game show.
You’ve already earned 1000 dollars in the first round when you rotate a wheel and landed on “BONUS”. Now you have two choices.
You’ll get a guaranteed 500 dollars or flipping a coin. If you get heads, you win a 1000 dollars bonus, but if its tails, you get no bonus at all.
In the second round, you’ve earned 2000 dollars and then you land on the “PENALTY”. Now again yo have two choices.
You can directly go for 500 dollars loss or try your luck at the coin flip. If its heads, you loose nothing, but if its tails, you loose 1000 dollars instead.
If you’re like most people, you must have chosen the guaranteed bonus in the first round and coin flip in the second round.
But wait…If you think deeply, it makes no sense. The odds and outcomes in both the rounds are same. See the picture below.
So, why does the second round seemed much scarier?
The answer lies in the phenomenon known as “Loss Aversion”.
Under rational economic theory, our decisions should follow a simple mathematical equation that weighs the level of risk against the amount at stake.
But studies have shown that the psychological impact of loosing something is twice as strong as the positive impact of gaining the same thing.
Loss Aversion is one cognitive bias that arrives from heuristics (problem solving approaches based on previous experience and intuition) rather than careful analysis and these mental shortcuts can lead to irrational decisions. Not like falling in love or bungee jumping off a cliff, but logical fallacies that can easily be proven wrong like believing earth is flat.
Situations involving numbers are very bad for applying heuristics. In an experiment, students were divided into two groups.
The first group was asked whether Mahatma Gandhi died before or after age 9 and second was asked whether he died before or after age 140.
Both numbers were obviously way off but when students were asked to predict his actual age when he died, the first group’s average came out to be around 50 and second group’s average came out to be around 67. Well, his actual age was 78.
Clearly the information given initially was irrelevant, still it affected the students’ estimates. This is an example of the anchoring effect and it’s often used in marketing and negotiations to raise the prices that people are willing to pay.
So, if heuristics are leading to wrong decisions, why do we even have them?
Well, because they can be quite effective. For most of the human history, survival depended on making quick decisions with limited information. When there is no time for making rational decisions, heuristics can sometimes save our lives.
So, in nutshell, our brain is way complex than we can even think.
When you encounter a situation involving numbers, probability or multiple details (flipping a coin), pause for a second and think because intuitive answer might not be the right one.