Summary Chapter 8
• Numerous examples of behavior contradict the predictions of the standard
rational choice model. People often fail to ignore sunk costs. They play
tennis indoors when, by their own account, they would prefer to play
outside. They behave differently when they lose a ticket than when they
lose an equivalent amount of cash. Psychologists argue that such behavior
is the result of limitations in human cognitive capacity. People use mental
accounting systems that reduce the complexity of their decisions,
sometimes at the expense of consistency with the axioms of rational choice.
• An important class of departures from rational choice appears to result
from the asymmetric value function described by Kahneman and Tversky.
In contrast to the rational choice model, which uses a utility function defined
on total wealth, Kahneman's and Tversky's descriptive theory uses a value
function defined over changes in wealth. Unlike the traditional model, it
gives losses much heavier decision weight than gains. This feature makes
decisions extremely sensitive to how alternatives are framed. For example,
if a loss is combined with a slightly larger gain, the net effect typically
receives a positive evaluation, as it would under the rational choice model.
But Kahneman and Tversky suggest that when gains and losses occur as
discrete events, people tend to evaluate their effects separately, in which
case the impact of the loss tends to outweigh that of the larger gain. A loss
combined with a slightly larger gain produces a positive effect, whereas
taken separately their net effect is negative.
• Another source of suboptimal decisions is failure to anticipate how we will
adapt to different consumption experiences over time. In choosing between
two goods, people tend to favor the alternative that provides greater
satisfaction at the moment of decision. Evidence suggests, however, that
the satisfaction provided by some goods and activities tends to decay
quickly over time, whereas for others it decays less quickly or even
increases. The upshot is a tendency to spend too much on goods and
activities in the former category, and too little on those in the latter.
• Decisions under uncertainty also often violate the prescriptions of the
expected utility model. Here, too, the asymmetric value function provides a
consistent description of several important patterns. People tend to be risk
averse in the domain of gains but risk seeking in the domain of losses. The
result is that subtle differences in the framing of the problem can shift the
mental reference point used for reckoning gains and losses, which, in turn,
can produce radically different patterns of choice.
• Another important departure from rational choice occurs in the heuristics,
or rules of thumb, people use to make estimates of important decision
factors. The availability heuristic says that one way people estimate the
frequency of a given class of events is by the ease with which they can recall
relevant examples. This leads to predictable biases because actual
