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Chapter 12

BUS 272 Chapter Notes - Chapter 12: Risk Aversion, Bounded Rationality, Confirmation Bias


Department
Business Administration
Course Code
BUS 272
Professor
Lieketen Brummelhuis
Chapter
12

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BUS 7 Chapter
HOW TO MAKE DECISIONS
Decision is a choice made from two or more alternatives.
RATIONAL DECISION MAKING MODEL
Rational refers to choices that are consistent and value-maximizing within
specifics constraints
Rational decision making model a six step decision making model that
describes how individuals should behave in order to maximize some outcome
1. Define the problem
2. Identify the criteria
3. Allocate weights to the criteria
4. Develop alternatives
5. Evaluate the alternative
6. Select best alternative
The model assumes that the decision maker has all the information necessary to
identify all options
HOW PPL ACTUALLY MAKE DECISION
Most decision in the real world don’t follow the rational decision making model.
Most decisions are made by judgment rather than by a model
Bounded rationality is a form of decision making which accepts that there are
cognitive limits to an individual’s knowledge and capacity to act rationally
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Because human mind cannot formulate and solve complex problems with
full rationality, we operate within BR. We construct simple models
Satisficing seeking solutions that are satisfactory and sufficient. When we
choose the first acceptable option rather than the most optimal
Bounded rationality usually leads us to satisficing
Intuition decision making an unconscious process created from distilled
experience. Occurs outside conscious thought, relied on holistic association or
links between disparate pieces of information, is fast and is affectively charged
meaning it’s engaged with emotions
the least rational way of making decision
JUDGEMENT SHORTCUTS
To minimize efforts and void trade-offs ppl tend to rely to heavily on experience,
impulses, gut feeling and convenient rules of thumb. Shortcuts can be helpful but
sometimes they lead to distortion of rationality.
Overconfident Bias believing too much in our own ability to make good
decisions.
People who’s intellectual and interpersonal abilities are weakest are most
likely to overestimate their performance and ability
The more optimistic, the less successful = being too overconfident means
less time planning for how to avoid mistakes
Biggest problem to decision making
Anchoring Bias is a tendency to fixate on initial information and fail to
adequately adjust for subsequent information
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Occurs because the mind appears to give a disproportionate amount of
emphasis to the first information it receives
Confirmation Bias selecting and using only facts that support our decision
Connected to Selective perception
Availability Bias Emphasizing information that is most readily at hand and vivid
Events that evoke emotions that are vivid, or have occurred recently tend to
be more available in our memory. As a result we tend to overestimate
unlikely events
This explains why managers when doing annual performance reviews tend
to give more weight to recent behavior than to that of 6 months ago
Escalation of commitment refers to staying with a decision even when there is
clear evidence that it’s wrong.
It’s more likely to occur when ppl view themselves responsible for the
outcome. The fear of failure biases the way we search for and evaluate info
so that we choose only the info that supports out decision.
Sharing of decision authority can lead to higher escalation of commitment,
because it makes decision more public.
Awareness of sunk cost reduced EOC
Randomness Error the tendency for people to think they can predict the
outcome of random events
Especially when we turn imaginary patterns into superstitions.
Risk Aversion tendency to prefer a sure thing over a risky outcome
You do everything to prevent loss (at a casino if your loosing you’re more
likely to keep gambling to avoid the loss and get your money back)
Sticking with a strategy that has worked in the past is risk aversion but lead
to stagnation
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