Psychology describes a phenomenon called cognitive bias. Broadly speaking, a bias is one of several thinking patterns common to all our brains that, in particular situations, lead us to decisions that aren't entirely rational. One such bias can be traced back to the experiments of Kahneman and Tversky (1979). They recruited a group of people and split them into two, with each group facing a decision similar to the following:
Group One
Suppose you already have $1,000
Option A – a 50% chance of gaining an extra $1,000
Option B – a guaranteed extra $500
Group Two
Suppose you already have $2,000
Option A – a 50% chance of losing $1,000
Option B – a guaranteed loss of $500
How would you choose in each scenario? The experiment's results showed that among the participants in Group One, 16% chose A and 84% chose B; conversely, in Group Two, 69% chose A and only 31% chose B.
But if you think about it carefully, Options A and B are in fact identical across the two groups. With Option A, there's a 50% chance of ending up with $2,000 and, if luck runs the other way, only $1,000. With Option B, you end up with $1,500 in hand for certain. The only difference between the two groups lies in how the options are phrased: Group One frames them in terms of "gains", while Group Two frames the problem in terms of "losses". That difference in framing alone produced a striking divergence in how the two groups decided. Kahneman and Tversky concluded that people are more willing to take on risk to avoid a loss, yet unwilling to risk what they already have (i.e. the $500 of Option B in Group One).
Cognitive biases like this have wide-ranging applications. Take, for instance, a sales slogan retailers love — "while stocks last" — which taps into our willingness to take on risk to avoid a loss (i.e. the risk of buying the wrong, unsuitable product. Think about it: have you ever bought something useless because a limited-time promotion rushed you into it?). Many people take cognitive bias as proof that humans are irrational creatures, but from another angle these so-called "biased" patterns of thinking are not just rational — they are, rather, wisdom accumulated over many years of biological evolution, capable of guiding us to the right decision in the vast majority of situations.
How so? Let's think back to Kahneman and Tversky's experiment. Granted, within the controlled setting of a psychology experiment, Options A and B for the two groups are identical. But what about in real life? Suppose, for example, you were originally a Hongkonger on a middle-class income, and you now have a 50% chance of acquiring a tycoon's entire fortune, or a guaranteed half of it — most people, I'd wager, would choose the latter. But what about for the tycoon? If he faced a 50% chance of losing his entire fortune and reverting to an ordinary middle-class life, or a certain loss of half of it — and if the tycoon happened to be founding a company, where losing half his capital would leave him insolvent and ultimately bankrupt — he would choose to gamble, since that at least gives him a 50% chance of coming through unscathed.
The examples above illustrate that some experiments on cognitive bias, once understood in context, make clear that what looks like a failure to read the situation is in fact perfectly reasonable. When it comes to gaining extra resources, people generally won't refuse, preferring to come away a little better off than empty-handed. Losses, however, are a different matter. Because people make plans for the resources in their hands — having money, say, they'll plan to buy property, support their children, or start a business — the moment they lose what they assumed was theirs to deploy, those plans fall into disarray, so the decision tilts towards taking on risk to protect the plan from unravelling. Seen this way, the irrational turns out to be rational after all.
Cognitive biases come in countless varieties, and a fair number of them, examined closely, reveal their practical value. Of course, modern society is hardly short of examples where cognitive bias is deployed to sway people's decisions, especially in fields like commerce and marketing. So understanding cognitive bias is the first step towards keeping yourself from making irrational decisions. At the very least, the next time you spot cognitive bias being used to push a sale, you can remind yourself to pause and reconsider whether you really need the product at all.
References:
Kahneman, D. & Tversky, A. (1979). “Prospect Theory: An Analysis of Decision under Risk”. Econometrica. 47 (4): 263–291. doi:10.2307/1914185.
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