Thinking, Fast and Slow is the book that every behavioural economics enthusiast should read at least once in their lifetime. The author is nothing less than Daniel Kahneman, the psychologist awarded with the Nobel prize in economics in 2002 for his work on human judgement and decision making under uncertainty, which combines psychological research with economic science. Thinking, Fast and Slow was published in 2011 and summarizes the findings of Mr Kahneman’s work during most of his career, often alongside with his valued collaborator and beloved friend, Amos Tversky, to whom the book is dedicated.
The title of the book already expresses the dichotomy that stands at the core of his work, the recurrent duality that characterizes human thinking. Kahneman introduces us to the two systems, two species and the two selves that are intrinsic in the nature of humans.
THE TWO SYSTEMS
Human thinking follows two systems very different in functions and approaches to reality, frequently contrasting one with the other and hence essential one for the other. System 1, the more intuitive component of the human mind, is fast and effortless but unfortunately also error prone. Its perpetual companion is System 2, the more rational entity: slower, self-conscious, effortful, and usually delivering right and rational solutions.
But how do such conflicting entities manage to coexist and drive us to what we call thinking? Essentially, the process is the following: System 1 goes through a continuous assessment of reality, building a model of what it considers to be normal and trying to spot whatever surrounds us that contradicts or challenges it. It then tries to find solutions and explanations to those unusual occurrences in the fastest way possible, often using mental shortcuts known as heuristics and association of ideas to exploit its previous experiences and knowledge. Due to its non-painstaking and crude practices, at this stage, it is very easy to incur in what is called a “bias”, a systematic error resulting in a deviation from rationality. System 2 comes into play whenever a stronger level of attention is required, and System 1’s approach, with all its tricks and gimmicks, no longer fits the situation and is surprised by the lack of normality it is dealing with.
The activities performed by System 2 are very demanding in terms of energy and focus, and this causes the “laziness” that characterizes the System, which unlike the first one, always operative, will activate itself only when it is truly necessary to do so (and sometimes not even then).
Even though the second system acts following rationality, it is not undeceivable. If the level of cognitive occupation is too high, for example, System 2 will not be able to sustain the effort that it is required for it to perform its function and its quest for “abnormality” will fail.
THE TWO SPECIES
Now, you might be wondering: “Two species in the human race? That doesn’t make sense!”, and you are exactly right! What Daniel Kahneman refers to when talking about a second species, is actually an invention of economists. We are talking about the “Homo Economicus”, also called Econs. Unlike the “Homo Sapiens” (or Humans), Econs are perfectly rational, absolutely untouched by their very own emotions or impulses (you could say that they don’t even feel any) and therefore never subject to mistakes. Economic theory is based on the assumption that the world is inhabited exclusively by Econs, or at least in a measure such that the irrationality of the few Humans would be exploited and neutralized by them. What economists didn’t realize is that perfect rationality is only a myth, and the reason for this lies in the irrationality of System 1. As we mentioned already, the heuristics used by this system may (and often do) lead to biases, which are the underlying difference between we Humans and the Econs.
The main source of biases in System 1 is its innate tendency to make sense of things by finding casual explanations, even when a casual explanation doesn’t exist at all (such as in the case of random events). Humans are pattern seekers and see randomness as a phenomenon that is not allowed to present patterns of any kind, so when we think we detected one, we immediately reject stochasticity. Another mistake we all make is to consider small samples as representative of big ones. We all know that big sample size is the cornerstone of statistical analysis, but we can’t really seem to be applying this concept in real life, especially when the small sample seems to confirm our own theories. This leads to a natural difficulty if not incapacity in dealing with probabilities, which can be cured, though not completely, by studying the math behind statistical events. Be aware that even experts in mathematics and statistics, especially due to their overconfidence, may still unconsciously fall in the traps of biases from time to time!
Being Humans and not Econs have an impact also on how we make decisions. To accommodate the effects that having a System 1 comports, Kahneman and his colleague Amos Tversky developed a new economic theory, the famous Prospect Theory, in which the idea of utility is different from the generally accepted one.
Interestingly, the concept of risk assumes different meanings to the same individual in different situations: Humans tend to be risk-averse when their own wealth is good, but turn to be risk-seeking when they already incurred in losses and their wealth is negative or close to zero: the value associated with gains is different and not as strong as the value of losses of the same magnitude. The revolutionary introduction of a reference point that tells in which state is the individual when they evaluate the possibility of a gain or a loss is what allows prospect theory to apply to the behaviour of Humans. The dynamism of this reference point allows for situations that economists would define as irrational, such as the contradiction of one’s own personal choices when facing the same decision in different situations.
Despite all the differences between the two species, there is one thing that they have in common, and that is confidence. In the case of Econs, confidence is a must: there is no reason to doubt of a perfectly rational mind. When talking about Humans, instead, we may want to talk of over-confidence. Humans are often not aware of their biases and of their flaws in the interpretation of probabilistic situations, and
they struggle to recognize them even when they are given evidence that they are not being totally rational.
THE TWO SELVES
When making choices, we often recur to our own past experiences to judge what will benefit us the most in the future. We use memory to evaluate the level of utility that we are likely to get and we try to choose the option that will maximize it. Does this lead us to completely rational choices, the best that we can do in our interest? Not necessarily. Let me introduce you to a last interesting duo: the Experiencing Self and the Remembering Self. The Experiencing Self assesses every moment of reality as it lives it, through what is called Experiencing Utility, a measure of how much pain or pleasure we undergo. What we actually listen to is the Remembering Self, which assess Decision Utility, that is a measure of the “wantability” of the object/activity we are examining. Decision Utility is what is known in Economic Theory as Expected Utility. Econs’ Experiencing Utility and Decision Utility are expected to coincide: they desire what gives them pleasure and enjoy what they choose for themselves. Memory and experience in the case of Humans, though, are different from each other and consequently, the two utilities are different too. Think about going on a lovely trip having a great time for a couple of weeks, but on the last day, something unpleasant happens and ruins the memory of it. Memory is like a summary of the experience and it can be influenced by small parts of the experience itself that are particularly bad or good but are not representative of the experience as a whole. This can make us choose things that are not the best for us, which is irrational, but can also have an impact on the evaluation of our own happiness.
In some cases, external intervention in the choice can help overcome the issues coming from the discrepancies between the two selves, by imposing some decisions that our memories would have make us avoid, but that leads to good experiences.
THE TWO SYSTEMS
- You might want to challenge your own two Systems following this link: https://youtu.be/vJG698U2Mvo
THE TWO SPECIES
- Prospect theory utility graph from: https://psychology.wikia.org/wiki/Prospect_theory
Other interesting readings:
- The Undoing Project, on the friendship and collaboration between Kahneman Tversky that lead to a great part of the work contained in “Thinking, Fast and Slow”