Welcome to lesson seven on decision and choice. We'll be talking about how people make choices, and how they can make them better. The first person we know of who tried to devise a systematic way to make people's choices better was a fifth century BC Chinese philosopher named Mozi. But he was a couple thousand years ahead of his time and a continent away from where he might have had the most impact. He's most famous for developing a theory of logic. And he invented what we'd call today cost-benefit analysis. A procedure where you spell out the possible courses of action. You note the possible costs and the possible benefits of each action. And you choose the action with the best pattern of benefits versus costs. Which we call the best net benefit. Mozi faded from view in China, neither his logic system nor his cost benefit analysis held people's interest there. The next famous thinker that we know of to propose the formal cost benefit analysis was the French philosopher Blaise Pascal. In the process, he also invented what's come to be called a payoff matrix. And the theory of cognitive dissonance. Pascal wanted us to think about whether to believe in God this way. If God exists, and we believe in him, The reward is eternal life. If God exists and we do not believe in him, The consequence is eternal damnation. If God does not exist but we believe he does, the loss is slight, maybe giving up some guilty pleasures and selfish behavior. If God does not exist and we believe he does not exist the gain is also slight, mostly being able to indulge in those selfish behaviors. I will make a point about Pascal's signs here, he probably got them reversed. Not that it's important, because it's not a big deal. But there is evidence that unselfish people are actually happier than more selfish people. And if you manipulate somebody into doing something nice for someone else it makes them quite happy. Pascal realized that this matrix, this two by two table, is not going to convince you. You can't just grunt and produce belief in God. In his solution to this problem, he invented the theory of cognitive dissonance. One tenet of which is, if our beliefs don't fit with our behavior, this produces mental pain. Something has to change, either our beliefs or our behavior. We don't have direct control over our beliefs, but we do have control over our behavior. So Pascal said, start to behave as if you believe. Taking holy water, having masses set. What have you got to lose? We would say today that he got it just right. Change people's behavior and their hearts and minds will follow. The next installment on what we call decision analysis, came from Benjamin Franklin. He pointed out that making a decision can be difficult because as he said, all the reasons pro and con. Are not present to the mind at the same time. To get over this I divide a sheet of paper by a line into two columns. Writing over the one pro and the other con. I endeavor to estimate their respective weights, where I find one on each side that seem equal. I strike them both out. When each is thus considered, separately and comparatively, and the whole lies before me, I think I can judge better and am less able to take a rash step. This basic procedure has been elaborated quite a bit over the years. Economists say that for a decision of any consequence, you should choose from the set of possible actions the action that has the greatest net benefit. Benefit minus cost. Since Franklin's time, there have been successive revisions and amplifications of this procedure. Here's a description of the steps that would be endorsed by a decision analyst for an important decision such as which of three cars to buy. This is called a weighted decision analysis. So, you'd first list the features that are important to you. Cost, gas mileage, and so on. Put them into a table, and then you rank order how important each feature is to you, and you assign a weight to each feature. Based on it's rank. So out of 100 points cost is the biggest one, that gives 35%. Color's not terribly important. You weight that only .05. And you grade each option on each dimension. So Car A is very cheap, so it gets 9 out of 10. Car C is most expensive, so it gets a 3, and so on. When you compute each option's score, you multiply its score on a given dimension by that weight. Do that for each dimension and sum up all the numbers for that option. Turns out it's Car A. But maybe this is too simple. Who said you should limit what we call the choice space to three cars? How about a Mazda or a Volkswagen or Ford? Should you cast a wider net? And did you really look at every aspect of the three cars you're considering? The repair record, the trade-in value, the capacity of the trunk. How many reviews did you read? You could make a minor career out of making this choice. And I have friends who've practically done that and that's called trying to optimize your choice, getting the absolute best choice. And you need lots of information to do that. But it's sometimes not realistic. Just too much information about too many options. The economist and psychologist and computer scientist Herbert Simon. Said actually, it's often not rational to optimize. It's better to do what he called satisfice, which is a combination of the words satisfy and suffice. You should spend time and money in proportion to the importance of the decision. Now, that amendment is surely correct as far at it goes as a prescription. But it's actually not a very good description of how people actually behave when you go out into the wild and see what they're doing. People can spend more time shopping for a shirt than for a refrigerator. They can spend more time pricing barbecue grills than shopping for a mortgage rate. And I am guilty of spectacularly poor calibration of choice, time, in relation to choice importance, and most professors are guilty of the same thing. The most important decisions the professors ever make, the most important financial decision they ever make takes about a minute. And here's the way it goes. After they've been hired they visit the department administrator and one of the questions that he or she asksis how do you want to allocate your retirement investments as between stocks and bonds? What do most people do? Well most people do 50 50. That's what I'll do. Now over the past 70 years, that policy would leave you with much less money than if you put everything into stocks. But I remind you again, I'm not a real financial planner. So you should do some homework if you're confronted with this kind of decision. Maybe the most important modification to Franklin's list that's been proposed is to take probabilities of various outcomes into consideration. When there's uncertainty, you have to do something called calculate the expected value. So, let's say you've got two job offers, one at Fancypants and the other at Smartypants. Both stores have great clothes and you like the atmosphere. At both stores, your income would depend on how much you sell. So here's how you would calculate the expected value for a job where how much money you make depends on whether you meet the sales target or not. For Fancypants you get $700 if you meet the sales target. But you're not 100% sure you can meet it. Pretty sure. So you say a 90% chance. At Smartypants the sales target is higher and you're not sure you can reach it. Not at all sure. So you say, maybe a 20% probability that you could reach it. Then you multiply the value of each outcome by the probability of each outcome to get the expected value of each job. And turns out Fancypants wins, but that wouldn't necessarily have been obvious to you if you hadn't done a formal expected value analysis. Now let's consider an extremely complicated and consequential choice that a friend of mine actually had to face. He was a professor at a very good university in the Midwest. And was invited to go to a very good university in the Southwest to start a new center for a new field of medicine that he had founded. No such center existed. The alternative actions were to go or stay. The affected parties were my friend, his wife, their grown children in the Midwest, potential students and faculty at the center and the world people at large. Because probably that field of medicine would be more widely used and drawn upon if there were a center for it. Some of the benefits are easy to identify. Starting a new center and advancing his field, escaping Midwestern winters, higher salary, change of intellectual scenery. But the impact on the world, hard to assess. And the probabilities of some of these things, not so easy. Some costs are easy to identify and assign weights to, but hard to assess the probabilities for. So, the hassles of moving, who knows. Burdens of administration, could be a snap, you have a great assistant or maybe not. Leaving treasured friends and colleagues, hard to know how important that's going to be. The cost and benefits for my friend's wife were similar to those for him, but fewer costs and benefits needed to be calculated. Because her occupation was novelist, which is portable. In measurement, money works for salary, but how much money is it worth to have a January day of sun and 60 degrees versus clouds and 20 degrees? How much is the estimated pleasure of setting up a new center offset by the aggravation of recruiting staff for it and administering it? So why bother to do a cost benefit analysis at all in this wildly complicated situation? Because as Franklin said, your judgement will be better informed, and you will be less likely to make a rash decision. There's one more very important thing to say about decision making. I have a friend who once had to make a decision. It was very important and it involved both her love life and her work life. And so she sat down to systematically plot all the costs and benefits. And as she's finishing up, she says, darn, it's not working out. I have to come up with some more benefits for choice B. And there was her answer. The decision her analysis was pointing toward was not the one she was discovering that she truly wanted. Pascal said, the heart has its reasons of which reason knows nothing. And Freud said, when making a decision of minor importance I've always found it advantageous to consider all the pros and cons. In vital matters, however, by which he meant love and work. The decision should come from the unconscious, from somewhere within ourselves. So, my friend's heart quite properly overruled her head. But the heart is also influenced by information. And the unconscious does indeed do a lot of the work. As a matter of fact, there's increasing evidence that the unconscious mind can make some kinds of decisions better than the conscious mind. In any case, it's a qualitatively different kind of analysis that goes on in the conscious mind and the unconscious mind. So for the most important decisions, my advice is, do your homework, list your pros and cons, and throw the worksheet away. And sleep on it. In this next segment, we're going to discuss some surprising implications of cost benefit theory. That many people are unaware of.