Navigating decision-making under uncertainty.

how economies are effected under psychology-factors

Introduction:

Every day, we face challenges, and there's a science behind every challenge. The science is simple: for every challenge we face, we'll need to make a decision, and with every decision comes uncertainty. From choosing an insurance plan to deciding whether to trust a new opportunity, uncertainty looms large in our lives. But how do we make these opportunities?

Behavioral economics is a field that connects this bridge. Basically, it interconnects two subjects - psychology and economics. Interesting? Behavioural economics is a fascinating field where it offers insights into how we perceive risks, weigh probabilities, and choose when the future is unpredictable.

In the newsletter's first issue, we shall explore the science behind decision-making under uncertainty.

What is Decision-Making under Uncertainty?

When outcomes are unknown or probabilities of a certain event are unclear, decision-making becomes a complex process. Unlike decisions made under certain circumstances, uncertainty involves incomplete information with the influence of emotions and cognitive biases. Such examples include:

• Predicting the stock market's performance.

• Deciding on career changes during economic downturns.

• Response to unexpected events, like global crisis.

Key-Psychological Factors Influencing Decision-Making

Loss Aversion

All of us, tend to fear losses more than we appreciate the gains. This often leads to overly-cautious or over-thinking behaviour. This includes risk-aversive behaviour even when the potential rewards outweigh the risks.

Over-confident Biases

As humans, we tend to over-think situations, this causes us to over-estimate our ability to predict outcomes, leading to superficial decisions based on such biases.

Emotional and Cognitive Biases

We, as humans, often are dominated by our emotions causing a rift between the usual logic vs emotion bias. This is often sought as a key-factor which influences a person while choosing between two or more options.

Behavioral Economics Insights

Framing Effects

The way choices are presented can significantly impact decisions. For instance, people are more likely to opt for a medical treatment when its framed as having a 90% survival rate rather than a 10% mortality rate.

Prospect Theory

It is a psychological theory that describes how people make decisions when they're presented with alternatives that involve risk, or uncertainty. It was first proposed by- Amos Tversky and Daniel Kahneman. They said, that the theory was better accurately describing how decisions are made, compared with expected utility theory, often leading to irrational choices.

Risk over-estimation

Over-calculation of the risk leads to uncertainty, this can often overshadow logical reasoning. For example, during financial crises, fear often drives a person to sell their assets pre-maturely, over-calculating the future outcomes. While caution is natural, such decisions often ignore the potentiality of long-term benefits.

In the next issue, we'll explore how simple "nudges" can steer decisions towards better outcomes-- even in the face of uncertainty. Stay tuned!

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