Lecture 1
Book Chapter 1: Introduction to managerial decision making
The anatomy of decisions
The word judgement refers to the cognitive aspects of our decision making
process. In order to understand judgment one must identify the components of
the decision making process.
Rational decision making process:
1) Define the problem: accurate judgement is required to specify and
define the problem. Common mistakes being made here: defining the
problem in terms of a proposed solution, missing a bigger problem,
diagnosing the problem in terms of its symptoms.
2) Identify the criteria: mostly accomplishing more than one objective
3) Weight the criteria: the relative value placed on the criteria
4) Generate alternatives: identification of possible courses of action. The
optimal search continues until the cost of the search outweighs the value
of the added information.
5) Rate each alternative on all criteria separately: How well will each of
the alternative solutions achieve each of the defined criteria?
6) Compute the optimal decision: multiply the ratings of 5) by the weight
of each criterion 3), identify all criteria, accurately weight all criteria
according to their preferences, know all relevant alternatives, assess each
alternative based on each criterion, calculate and choose the alternative
with the highest perceived value.
System 1 and system 2 thinking
System 1: our intuitive system; fast, automatic, effortless, implicit and
emotional.
(People rely more on this system when stressed, rushed, busier an with more on
our minds)
System 2: reasoning that is slower, conscious, effortful, explicit and logical.
Most decisions are made through system 1 thinking; in most situations this
system is sufficient. Yet, system 2 logic should preferably influence our most
important decisions.
Most errors and biases will occur in system 1, but at the same time system 2 will
use some intuitive system 1 shortcuts. Also system 2 has problems with
adjusting.
The bounds of human attention and rationality
Rationality: decision making process that is expected to lead to the optimal result
given an accurate assessment of the decision maker’s values and risk
preferences.
, Based on how a decision should be made, instead of how it is made.
Individual judgement is bounded in its rationality and we can better understand
decision making by describing and explaining actual decisions than on how
decisions should be made
2 schools of thought
- Prescriptive models: developing methods for making optimal decisions
- Descriptive models: focus on how decisions are actually made.
Focus on the descriptive approach:
- Understanding our own decision making process helps to clarify where we
are likely to make mistakes and thus we can then identify when better
decision strategies are needed.
- The optimal decision often depends on behaviour of others; understanding
how they react to your behaviour is critical in making the optimal choice.
- Good advice about decision making is available but people do not follow it
because they do not understand how they make decisions
Why we satisfice: finding a satisfactory solution that is sufficient
- We often lack important information for problem definition etc.
- Time and cost constraints: influence quantity and quality of information
- Decision makers rely on a small amount of information in memory
- Intelligence limitations and perceptual errors: limit ability to accurately
calculate the optimal solution
A broader look at bias
Human judgement deviates from rationality, but how does it deviate?
People rely on a number of simplifying strategies, rules of thumb, called
heuristics. They serve as a mechanism for coping with the complex
environment surrounding our decisions.
In general they are helpful, but they can lead to severe errors as well.
New findings
- Decision making is bounded in 2 ways not precisely captured by the
concept of bounded rationality: willpower is bounded (we tend to give
greater weight to present concerns than future concerns), self-interest is
bounded: we care about the outcomes of others.
Introduction to judgmental decisions
Individuals use heuristics because it saves time which often outweighs the costs
of quality reduction. 4 general heuristics:
- The availability heuristic:
People assess the frequency, probability or likely causes of an event based
on how many/how easily instances or occurrences of that event are readily
available in memory. An event that evokes emotions and is vivid, imagined
Book Chapter 1: Introduction to managerial decision making
The anatomy of decisions
The word judgement refers to the cognitive aspects of our decision making
process. In order to understand judgment one must identify the components of
the decision making process.
Rational decision making process:
1) Define the problem: accurate judgement is required to specify and
define the problem. Common mistakes being made here: defining the
problem in terms of a proposed solution, missing a bigger problem,
diagnosing the problem in terms of its symptoms.
2) Identify the criteria: mostly accomplishing more than one objective
3) Weight the criteria: the relative value placed on the criteria
4) Generate alternatives: identification of possible courses of action. The
optimal search continues until the cost of the search outweighs the value
of the added information.
5) Rate each alternative on all criteria separately: How well will each of
the alternative solutions achieve each of the defined criteria?
6) Compute the optimal decision: multiply the ratings of 5) by the weight
of each criterion 3), identify all criteria, accurately weight all criteria
according to their preferences, know all relevant alternatives, assess each
alternative based on each criterion, calculate and choose the alternative
with the highest perceived value.
System 1 and system 2 thinking
System 1: our intuitive system; fast, automatic, effortless, implicit and
emotional.
(People rely more on this system when stressed, rushed, busier an with more on
our minds)
System 2: reasoning that is slower, conscious, effortful, explicit and logical.
Most decisions are made through system 1 thinking; in most situations this
system is sufficient. Yet, system 2 logic should preferably influence our most
important decisions.
Most errors and biases will occur in system 1, but at the same time system 2 will
use some intuitive system 1 shortcuts. Also system 2 has problems with
adjusting.
The bounds of human attention and rationality
Rationality: decision making process that is expected to lead to the optimal result
given an accurate assessment of the decision maker’s values and risk
preferences.
, Based on how a decision should be made, instead of how it is made.
Individual judgement is bounded in its rationality and we can better understand
decision making by describing and explaining actual decisions than on how
decisions should be made
2 schools of thought
- Prescriptive models: developing methods for making optimal decisions
- Descriptive models: focus on how decisions are actually made.
Focus on the descriptive approach:
- Understanding our own decision making process helps to clarify where we
are likely to make mistakes and thus we can then identify when better
decision strategies are needed.
- The optimal decision often depends on behaviour of others; understanding
how they react to your behaviour is critical in making the optimal choice.
- Good advice about decision making is available but people do not follow it
because they do not understand how they make decisions
Why we satisfice: finding a satisfactory solution that is sufficient
- We often lack important information for problem definition etc.
- Time and cost constraints: influence quantity and quality of information
- Decision makers rely on a small amount of information in memory
- Intelligence limitations and perceptual errors: limit ability to accurately
calculate the optimal solution
A broader look at bias
Human judgement deviates from rationality, but how does it deviate?
People rely on a number of simplifying strategies, rules of thumb, called
heuristics. They serve as a mechanism for coping with the complex
environment surrounding our decisions.
In general they are helpful, but they can lead to severe errors as well.
New findings
- Decision making is bounded in 2 ways not precisely captured by the
concept of bounded rationality: willpower is bounded (we tend to give
greater weight to present concerns than future concerns), self-interest is
bounded: we care about the outcomes of others.
Introduction to judgmental decisions
Individuals use heuristics because it saves time which often outweighs the costs
of quality reduction. 4 general heuristics:
- The availability heuristic:
People assess the frequency, probability or likely causes of an event based
on how many/how easily instances or occurrences of that event are readily
available in memory. An event that evokes emotions and is vivid, imagined
