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ARTHUR LEE
ANY stories about the Nobel prize winning psychologist Daniel Kahneman start with a puzzle. This is one of the favourites: A bat and a ball together cost $1.10. The bat costs $1 more than the ball. How much does the ball cost? Did you say 10 cents? More than half of a Princeton University economics class gave the same answer (as did most of my friends), and it is wrong. The thought process that produced this wrong answer is an example of what Prof Kahneman calls System 1 thinking. It is, he says, fast, effortless, associative. We just impulsively pluck out the most intuitively obvious-sounding answer. We dont stop to deliberate, especially when the question seems trivial. Less frequently, we practise what he calls System 2 thinking, which he describes as conscious, deliberate, slower, serial, effortful. (The right answer to the above question is 5 cents try System 2 thinking.) System 1 works well almost all the time, he says. The problem is when it comes to big decisions. You need to know when you must slow down and recognise situations where its better to calculate rather than follow your intuition. Mr Kahneman, who won the Nobel prize for economics in 2002 and teaches at Princeton University, is widely credited together with his collaborator for some 30 years, the late Amos Tversky of Stanford as being the founder of behavioural economics. One of the insights of this relatively new discipline is that when it comes to making decisions, people are often not the selfish, rational, far-sighted, profit maximisers that mainstream economists assume them to be and which forms the basis for many policy prescriptions. There are domains in which rationality provides a good approximation of behaviour, but there are other domains in which it is not even close, explains Prof Kahneman. For example, individuals attitudes to savings at least in the US are completely irrational, and there is a need for policy intervention to enhance rationality. Many mainstream economists still view behavioural economics with a mixture of curiosity and suspicion, but they are increasingly coming around, because some of its findings are too compelling to ignore. Prof Kahneman does not however consider himself an economist. Absolutely not, he says. I study judgement and decision-making. I never really made a transition into the field of economics. What happened is that some economists became interested in our work. I learnt some economics from my friends over the years, but these were friends who were interested in what I was doing. It is evident from Prof Kahnemans deeply introspective autobiography that his interest in the workings of the human mind goes back to his childhood. At the age of seven, in German-occupied France, he was already convinced, as his mother had told him, that people were endlessly complicated and interesting. About this fundamental truth, he was to discover more and more, in a lifetime of study of the human psyche. One of his key findings was that people suffer from various cognitive illusions, which affect their decisions and their behaviour. He has documented scores of these and inspired other researchers to find even more. One of the most common problems, he
The cost of having an idea for an individual investor is almost 4 per cent. That is enormous.
There are domains in which rationality provides a good approximation of behaviour, but there are other domains in which it is not even close.