Why We Make Foolish Decisions
Individuals frequently ensure poor decision making by failing to obtain even the most basic information necessary to make intelligent choices. Take, for example, the NSF-supported research of Howard Kunreuther of the University of Pennsylvania's Wharton School. He and his colleagues observed that most people living in areas subject to such natural disasters as floods, earthquakes, and hurricanes take no steps to protect themselves. Not only do they not take precautions proven to be cost-effective, such as strapping down their water heaters or bolting their houses to foundations; they also neglect to buy insurance, even when the federal government provides substantial subsidies.
What accounts for such apparently foolish decision making? Financial constraints play a role. But Kunreuther found the main reason to be a belief that the disaster "will not happen here." His research suggested "that people refuse to attend to or worry about events whose probability is below some threshold." The expected utility model, he added, "is an inadequate description of the choice process regarding insurance purchases."
Kunreuther next applied decision science to devising an alternative hypothesis for the behavior. First, he posited, individuals must perceive that a hazard poses a problem for them. Then they search for ways, including the purchase of insurance, to mitigate future losses. Finally, they decide whether to buy coverage. They usually base that decision on simple criteria, such as whether they know anyone with coverage. The research showed that, since people do not base their purchasing decisions on a cost-benefit analysis, premium subsidies alone did not provide the necessary impetus to persuade individuals to buy flood insurance.
Decision making within organizations is also riddled with systematic bias. One example is the familiar phenomenon of throwing good money after bad. Corporations frequently become trapped in a situation where, instead of abandoning a failing project, they continue to invest money and/or emotion in it, at the expense of alternative projects with higher expected payoffs. With NSF support, M.H. Bazerman of Northwestern University documented these stubborn tendencies in a variety of settings, and proposed corrective measures that organizations can take to counteract them.
Just as it supported game theory from the very early stages, NSF has funded research on the application of psychology to economic decision making from the field's infancy. That support yielded even faster dividends: Within a few years, the research had given rise to popular books advising managers and others on how to correct for error-prone tendencies and make better decisions. "We know that people bargain and interact, that information is imperfect, that there are coordination problems," NSF's Daniel Newlon explains. "NSF's long-term agenda is to understand these things. Even if they're too difficult to understand at a given time, you keep plugging away. That's science."