July 2005 | Click here to watch the TED Talk
The way we calculate our expected value (or what makes us decide) is as follows:
Expected Value = Odds of getting the value x Actual value we get
Which is usually problematic because of 2 reasons:
Reason 1: Bad calculations of the odds
We usually think that the most probable thing is the one that comes us first to memory.
- This can be true for calculating things like: How many dogs vs pigs on leashes are in London?
- It’s easy to recall dogs with leashes but not pigs, so one would probably answer dogs correctly.
But very often this approach leads to false conclusions whenever we only know one side of the story: What are the odds of dying drowned vs dying of asthma vs dying in a tornado vs dying in a firework-related accident?
- In this case, the first things that come to mind are the big events because we see them on the news more often and we can wrongly overestimate those ones and underestimate the ones we never know about:
|Cause of death||Estimate||Actual|
- The lottery is another great example. We see winners all the time but never (or not in the real proportion) losers.
Reason 2: Even worse calculation of the value
We compare value to the past instead of the present
Is a Big Mac worth $25?
- The true answer depends on the situation and the answer that we get to the question “What else can I do with $25?”. But instead, we relate it to what we’re used to pay.
- Most travellers would buy the trip they want if it was $2000 and at the moment of paying is on offer for $1500.
- But most travellers won’t buy the trip they want if it was $2000, they see an offer for $700 and, after they think about it, at the moment of paying it costs $1300.
We compare it to the possible value instead of the real one
We tend to buy the middle price, not the lowest and not the highest because compared to the others, it seems not too cheap but not too expensive either.
- You want to buy a stereo for your car and your neighbour has it for $200 but across town, someone sells it for $100. Would you drive?
- Now, if you wanted to buy a car and your neighbour had it for for $30,000 but across town, someone sold it for $29,900, would you make the drive?
- Most people say yes to the 1st option and no to the 2nd even though $100 are $100 no matter were they come from.
It gets even more complicated when we have to deal with time.
Most of us believe thad more is better and now is better than later. But what happens when these two things are in conflict?
- Would you prefer $50 now or $60 in a month?
- What about $50 in 12 months vs $60€ in 13 months?
In those cases we tend to compare and people who would prefer $50 in the first question often change their minds in the second question.
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