Bias N Heuristic

Cognitive Bias in Decision Making and
Heuristic Approach
MB2101-Decision Making
Santi Novani, Ph.D
School of Business and Management, ITB
*for internal use only (decision making course - MB 2101)

Distinguished Scholars in the Decision Making Field
Herbert Simon
Nobel Laurates 1978
“[is awarded the Nobel Price in 1978] "for his pioneering research into the decision-making process within
economic organizations"
source: https://www.nobelprize.org/prizes/economics/1978/summary/
Distinguished Scholar in the Decision Making Field
Daniel Kahneman
Nobel Laurate 2002
“[is awarded the Nobel Price in 2002] “for having integrated insights from psychological research into
economic science, especially concerning human judgment and decision-making under uncertainty“
source: https://www.nobelprize.org/prizes/economics/2002/summary/
Distinguished Scholar in the Decision Making Field
Gerd Gigerenzer
Max Planck Institute for Human Development, Berlin Germany
The author of Simple Heuristics that Makes Us Smart

Main Content
• System 1 vs System 2
• 3 Type of Heuristics - (Kahneman & Tversky, 1974)
• Representativeness Heuristics
• Availability Heuristics
• Anchoring Heuristics
• Other Type of Heuristics - (Goodwin & Wright, 2014)
• Will be taught during your tutorial class
LAST WEEK REVIEW
In an uncertain world, where NOT all relevant

alternatives, consequences, and probabilities
are known, we require heuristics and intuition
Even though, there are some biases regarding

how we try to judge the probability of the
uncertain situation
RISK vs. UNCERTAINTY
RISK :
How should we make decisions when all relevant alternatives, consequences,
and probabilities are known?
Neoclassical economics, behavioral economics
UNCERTAINTY :
How should we make decisions when NOT all relevant alternatives,
consequences, and probabilities are known?
Simple Heuristics that Makes Us Smart – Gerd Gigerenzer

Max Planck Institute for Human Development Berlin
System 1 vs System 2
Heuristics Deliberate DM*
What is Heuristics?
• (Herbert) Simon used the term bounded rationality to refer to the
fact that the limitations of the human mind mean that people have
to use ‘approximate methods’ to deal with most decision problems
and, as a result, they seek to identify satisfactory, rather than
optimal, courses of action.
• These approximate methods, or rules of thumb, are often referred to

as ‘heuristics’. source: [Goodwin & Wright, 2014]
What is heuristic?
• A 'heuristic is a method to help solve a problem, commonly
informal.
• It is particularly used for a method that often rapidly leads to a
solution that is usually reasonably close to the best possible
answer.
Why study heuristics and biases?
There are three related reasons for the focus on systematic error and inferential biases in
the study of reasoning.
First, they expose some of our intellectual limitations and suggest ways to improve the
quality of our thinking.
Second, errors and biases often reveal the psychological processes that govern judgment
and inference.
Third, mistakes and fallacies help the mapping of human intuitions by indicating which
principles of statistics or logic are non-intuitive or counter-intuitive. (Tversky and
Kahneman, 1982)
PAD634 (heuristics-biases.ppt) 11
3 Types of Heuristics
Kahneman & Tversky, 1974
1. Availability Heuristics
2. Representativeness Heuristics
3. Adjustment from an Anchor Heuristics
Availability Heuristics
• It assess the frequency, probability, or likely causes of an event

by the degree to which instances or occurrences of that event
are readily “available” in memory
• The frequency of a class or event is often assessed by the ease

with which instances of it can be brought to mind
• The problem is that this mental availability might be affected by

factors other than the frequency of the class
• 🡪 Judgment based on the available information in mind

Bias associated to Availability Heuristics (1)
1. When ease of recalls is not associated with
probability
Example:
• Watching a car accident increases subjective
assessment of traffic accidents
• People believe that car accidents cause more deaths than stomach
cancer in United Stated.
• This believes occur because car accidents get more exposure from media
than stomach cancer
Bias associated to Availability Heuristics (2)
2. Ease of imagination is not related to probability
Example:
i.e. Civil engineer in charge of construction project may
find it easy to imagine all the circumstances that could
lead to the delay of project such as strikes, adverse
weather condition, interruption in the supply of
material and equipment, geological problem. The
result could be a gross overestimate of the risk of the
project overrunning the deadline.
Biases Associated to Availability Heuristics (2)
3. Illusory correlation i.e. celebrity experienced divorced, then people usually correlate
(Chapman & Chapman married celebrity with divorce.
(1969))
Subjects might
overestimate the
correlation due to easier All people with beard correlate with terrorist
association of suspicion
with the eyes than other
body parts
Representativeness Heuristics
• We often judge whether object X belongs to class Y by how

representative X is of class Y
• Likelihood of a condition is judged by similarity to a condition,
mitigating factors notwithstanding
Biases associated with Representative
Heuristics (1)
1. Ignoring base-rate frequency
or base rate neglect, is when the base or original weight or
probability is either ignored or considered secondary.
Example:
i.e. if you find out that only 10% of the delegates at your
conference party were sales people then this should be clearly be
considered when you estimate the probability of a person being a
salesmen
Heuristics (2)
2. Expecting sequence of events to appear random
Example:
i.e., when a sequence of events generated by a random process
people expect the sequence of represent the characteristics of
randomness. Example tossing a coin six times. People tent to
expect the sequence of H-H-H-T-T-T to be less likely to occur then
the sequence of T-H-H-T-H-T
Heuristics (3)
3. Expecting chance to be self-correcting
Example:
i.e. If a fair coin is tossed and a long sequence of head appears,
many people will think that the occurrence of a tail on the next
throw is highly probable because the tail is overdue.
Heuristics (4)
4. Ignoring regression to the mean
Example:
i.e. people assume that, when an event follows an extreme event,
it will be maximally representative of the extreme event. But in
fact, they should considering the combination of chance factors
which unlikely to recur in the following period
Heuristics (5)
5. Conjunction Fallacy
The conjunction (or co-occurrence) of two events cannot be more probable than each
event on its own.
Example:
People were told that Linda majored in philosophy and was a social activist. Then they
ranked the probability of 8 statements about Linda.
– Linda is a bank teller
– Linda is a bank teller and a feminist
80% of people rated the statement “Linda is a bank teller and a feminist” as more likely than “Linda is a bank
teller”
This contradicts the fact that the probability of x is greater than the probability of x and y co-occurring (when x
and y are independent events)
Anchoring and Adjustment
People often estimate by adjusting an initial value until a final
value is reached
The initial value, or starting point, may be suggested from historical
precedent, from the way in which a problem is presented, or from
random information
Unfortunately, the adjustment from these initial values is often

insufficient
Anchoring and Adjustment
• Value is often set by anchors or imprints in our minds which we then
use as mental reference points when making decisions.
• Example of price anchoring:
• ”big price drop” campaigns by supermarket
• Price anchors are used in menus at restaurants and in coffee shops
Anchoring Heuristics
What is this Jacket Really Worth?
The offer becomes more persuasive with social proof used as a

secondary anchor
Anchoring Heuristics
Leverage Multiple Unit Pricing
Buying in bulk is money-saving, something people

don’t say no to
Summary: Heuristics and Biases
• Thereare several common heuristics
people employ to estimate probabilities
• Representativeness of a class by an object
• Availability of instances as a frequency
measure
• Adjustment from an initial anchoring value
• Allheuristics are quite effective, usually,
but lead to predictable, systematic
errors and biases
• Understanding biases might decrease
their effect
Discussion
• The Applications of Heuristics in Business
The Applications of Heuristics in Business
What kind of Heuristics concept is applied in the following ads?
The Applications of Heuristics in Business
What kind of Heuristics concept is applied in the following?
• Marketing: “In a marketing campaign, do not spend on research

more than 5% of the campaign’s budget
• .” Explanation: The research budget for a campaign can vary widely

and there is a tendency to spend too much on research. This rule of
thumb limits it to 5%. A variant of this heuristic limits the research
budget to the product/industry margin, making the heuristic usable
across industries.
Thank You

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Cognitive Bias in Decision Making and

Santi Novani, Ph.D

School of Business and Management, ITB

*for internal use only (decision making course - MB 2101)

The author of Simple Heuristics that Makes Us Smart

In an uncertain world, where NOT all relevant

Even though, there are some biases regarding

Simple Heuristics that Makes Us Smart – Gerd Gigerenzer

• These approximate methods, or rules of thumb, are often referred to

• It assess the frequency, probability, or likely causes of an event

• The frequency of a class or event is often assessed by the ease

• The problem is that this mental availability might be affected by

• 🡪 Judgment based on the available information in mind

• We often judge whether object X belongs to class Y by how

Unfortunately, the adjustment from these initial values is often

The offer becomes more persuasive with social proof used as a

Buying in bulk is money-saving, something people

• Marketing: “In a marketing campaign, do not spend on research

• .” Explanation: The research budget for a campaign can vary widely

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