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Think and Share
What do you understand by the term “cognitive bias”?
- What do you understand by the term “cognitive bias”?
- Can you think of a situation where you or someone you know made a decision that was influenced by emotions rather than logic?
- Based on the title of the episode and the key terms, predict what you think the episode will cover. Write down at least three topics or questions you expect to hear about during the listening.
Think and Decide
Ace it
Grammar
1. Complete the sentences using the appropriate conditional form (Zero, First, Second, or Third Conditional)
- If people recognize their cognitive biases, they __________ (make) better decisions.
- If you had studied behavioral economics more thoroughly, you __________ (understand) the impact of loss aversion on financial decisions.
- Risk-seeking behavior often occurs when people __________ (feel) they have nothing to lose.
- If we __________ (address) the understudied problems in psychological research, we could gain valuable insights.
- If the financial crisis of 2008 __________ (not happen), many investors would have avoided significant losses.
2. Rewrite the sentences using conditionals.
You don’t understand loss aversion. You might make irrational financial decisions.
- If you __________, you __________.
They studied the impact of risk-seeking behavior. They would have made better investment choices.
- If they __________, they __________.
The financial sector ignored confirmation bias. Many problems arose.
- If the financial sector __________, many problems __________.
3. Create sentences using the given prompts.
Cognitive biases / impact / financial decisions
- If people __________, they __________.
Behavioral economics / address / more effectively
- If researchers __________, they __________.
Overconfidence / lead / poor decision-making
- If someone __________, they __________.
4. Say whether you agree with these key insights
- Cognitive Biases Are Unavoidable
- Insight: Even when we believe we are making rational decisions, we are often influenced by subconscious biases. These biases operate below our awareness, affecting everything from everyday choices to major life decisions.
- Example: People tend to overvalue information that confirms their existing beliefs (confirmation bias), which prevents them from considering alternative perspectives.
- Heuristics Can Lead to Errors
- Insight: Heuristics, or mental shortcuts, help us make decisions quickly, but they often come at the cost of accuracy. While useful in many situations, heuristics can lead to flawed reasoning and poor judgment.
- Example: The availability heuristic may cause us to overestimate the likelihood of dramatic but rare events simply because they are more memorable.
- Loss Aversion Shapes Risk Behavior
- Insight: Loss aversion—a bias that makes people more sensitive to losses than to equivalent gains—often drives people to make overly cautious decisions or, paradoxically, risk-seeking choices to avoid potential loss.
- Example: Investors may hold on to losing stocks longer than they should, hoping to avoid locking in a loss, which often leads to greater financial damage.
- Confirmation Bias Reinforces Beliefs
- Insight: People are inclined to seek out and trust information that supports their preexisting beliefs while disregarding information that contradicts them. This can lead to a skewed understanding of reality and poor decision-making.
- Example: In politics or social media, people may only consume news from sources that align with their opinions, creating an echo chamber effect.
- Overconfidence Bias Distorts Decision-Making
- Insight: Overconfidence in one’s abilities or knowledge leads to risky decisions or dismissing advice or facts that contradict one’s views. This bias can result in significant errors in judgment, particularly in complex situations.
- Example: Overconfident investors or leaders may take unwarranted risks, believing they are less prone to mistakes than others.
- Reflective Thinking Can Mitigate Biases
- Insight: Slowing down and engaging in reflective thinking can help mitigate the influence of cognitive biases. However, in fast-paced environments, this is not always feasible, and people often rely on their instincts instead.
- Example: Taking time to question one’s assumptions and critically evaluate evidence can lead to more rational, well-considered decisions.
- Behavioral Economics Explains Irrational Financial Choices
- Insight: Behavioral economics shows how psychological factors influence financial decisions, often in irrational ways. People are not purely rational actors and are prone to biases like loss aversion, overconfidence, and the framing effect.
- Example: Investors may follow trends due to fear of missing out (FOMO), even when rational analysis would suggest caution.
- Bias Blind Spot
- Insight: People tend to recognize biases in others but fail to see them in themselves (bias blind spot), which makes it difficult for them to correct their own flawed thinking.
- Example: Someone might easily spot another person’s overconfidence but fail to recognize their own susceptibility to the same bias.
- The Difficulty of Making Unbiased Decisions
- Insight: Overcoming cognitive biases is incredibly difficult, as they are deeply embedded in human psychology. While education and awareness can help, most people will continue to be influenced by biases to some extent.
- Example: Even when people learn about cognitive biases, they often still fall prey to them in high-pressure situations or when making rapid decisions.
- The Importance of Critical Thinking and Questioning
- Insight: To combat the effects of biases, individuals must engage in active questioning, seek diverse viewpoints, and practice critical thinking. This requires effort and a willingness to challenge one’s assumptions.
- Example: Actively seeking out information that contradicts your views, and reflecting on why it makes you uncomfortable, can lead to better, more informed decisions.
5. Choose a statement and comment
- “We like to believe we’re rational, but most of our decisions are shaped by hidden biases we can’t control. Can we ever truly make unbiased choices?”
- “The opinions we trust the most might be the ones that reinforce our own beliefs. Should we really trust our instincts, or are we just trapping ourselves in a bubble of our own biases?”
- “Slowing down and reflecting more sounds like a good solution, but in a fast-paced world, is it realistic to expect people to question their every decision?”
Transcript
Government reports and studies over the past decade or so have cited experts as believing that cognitive bias may have played a role in a number of very significant intelligence failures and yet it remains an understudy problem. But the area of our lives in which these systemic mistakes have the most explosive impact is in the world of money. The moment money enters the picture, the rules change. Many of us think that we’re at our most rational when it comes to decisions about money. We like to think we know how to spot a bargain, to strike a good deal, sell our house at the right time, invest wisely. Thinking about money the right way is one of the most challenging things for human nature. But if we’re not as rational as we like to think and there is a hidden force at work shaping our decisions, are we deluding ourselves? Money brings with it a mode of thinking; it’s changed the way we react to the world. When it comes to money, cognitive biases play havoc with our best intentions.
There are many mistakes that people make when it comes to money. Kahneman’s insight into our mistakes with money is to revolutionize our understanding of economics. It’s all about a crucial difference in how we feel when we win or lose and our readiness to take a risk. Our willingness to take a gamble is very different depending on whether we’re faced with a loss or a gain.
In the first case, you’re given 10 pounds that’s not yours, put it in your pocket, take it away, spend on a drink on the south bank later. Okay, then you have to make a choice about how much more you could gain. You can either take a safe option, in which case I’ll give you an additional five, or you can take a risk – I’m gonna flip this coin. It comes up heads, you win ten, but if it comes up tails, you’re not gonna win any more. Would you choose the safe option and get an extra five pounds or take a risk and maybe win an extra ten or nothing? Most people presented with this choice go for the certainty of the extra five. In a winning frame of mind, people are naturally rather cautious.
But what about losing? Are we similarly cautious when faced with a potential loss? This time, you’re given 20 pounds, and again you must make a choice. Would you choose to accept a safe loss of 5 pounds or would you take a risk? I’m gonna flip this coin, and it comes up heads, you don’t lose anything, but if it comes up tails, then you lose ten pounds. In fact, it’s exactly the same outcome in both cases. You face a choice between ending up with a certain 15 pounds or tossing a coin to get either 10 or 20. The crucial surprise here is that when the choice is framed in terms of a loss, most people take a risk. Our fast system one makes a rough guess based on change, and that’s all there is to it. System one doesn’t like losing.
If you were to lose 10 pounds in the street today and then find ten pounds tomorrow, you would be financially unchanged, but actually, we respond to changes. The pain of the loss of ten pounds looms much larger. It feels more painful. In fact, you probably have to find 20 pounds to offset the pain that you feel by losing ten. At the heart of this is a bias called loss aversion, which affects many of our financial decisions. People think in terms of gains and losses, and in their thinking, typically, losses loom harder than gains, even by a factor of two or a little more than two. This is a vital insight into human behavior, so important it led to a Nobel Prize and the founding of an entirely new branch of economics.
When we think we’re winning, we don’t take risks, but when we’re faced with a loss, frankly, we’re a bit reckless. Loss aversion doesn’t just affect people making casual 5-pound bets; it can affect anyone at any time, including those who work in the complex system of high finance, in which trillions of dollars are traded. In our current complex environment, we now have the means as well as the motive to make very serious and risky decisions. The bedrock of economics is that people think rationally, they calculate risks, rewards, and decide accordingly. But we’re not always rational; we rarely behave like Mr. Spock. Most of our decisions, we use fast, intuitive, but occasionally unreliable system one, and in a global financial market, that can lead to very serious problems.
Understanding these pitfalls has led to a new branch of economics, behavioral economics, thanks to psychologists like Hirsh Efrain. It’s beginning to establish a toehold in Wall Street, as it takes account of the way we actually make decisions rather than how we say we do. The financial crisis, I think, was as large a problem as it was because certain psychological traits like optimism, overconfidence, and confirmation bias played a very large role among a part of the economy where serious mistakes could be made. But for as long as our financial system assumes we are rational, our economy will remain vulnerable. If the regulators had listened to behavioral economists early on, we would have designed a very different financial system, and we wouldn’t have had the incredible increase in the housing market and this financial catastrophe.