Academic journal article Michigan Law Review

Are People Probabilistically Challenged?

Academic journal article Michigan Law Review

Are People Probabilistically Challenged?

Article excerpt

ARE PEOPLE PROBABILISTICALLY CHALLENGED? THINKING, FAST AND SLOW. By Daniel Kahneman. New York: Farrar, Strauss and Giroux. 2011. Pp. 3, 418. Cloth, $30; paper, $17.

INTRODUCTION

Daniel Kahneman's1 recent book, Thinking, Fast and Slow, is a mustread for any scholar or policymaker interested in behavioral economics. Behavioral economics is a young, but already well-established, discipline that pervasively affects law and legal theory.2 Kahneman, a 2002 Nobel Laureate, is the discipline's founding father. His pioneering work with Amos Tversky and others challenges the core economic concept of expected utility, which serves to determine the value of people's prospects.3 Under mainstream economic theory, the value of a person's prospect equals the prospect's utility upon materialization (U) multiplied by the probability of the prospect materializing (P).4 When the prospect is advantageous, its utility is a positive sum that augments the person's well-being. When the prospect is disadvantageous, its utility is a negative sum (a disutility) that decreases the person's well-being. Under both scenarios, the full amount of the person's utility or disutility is discounted by the prospect's probability of not materializing. Economic theory holds that the expected-utility formula, P . U, ought to determine a rational person's choice among available courses of action. The action yielding the highest expected utility is the one that the person ought rationally to prefer over the alternatives.

This normative assumption underlies all economic models that predict human behavior. For example, when a legal system apprehends 10 percent (0.1) of all drivers who run a red light and forces each violator to pay a $300 fine, the expected fine for each prospective violator equals $30. Economic theory consequently predicts that a risk-neutral driver will run a red light when her expected gain from doing so exceeds $30. Hence, when the average social loss from a red-light violation (including the marginal increase in society's cost of enforcing the law) exceeds $30, economically minded scholars and policymakers recommend upping the fine to a sum that will eradicate the drivers' antisocial incentive to violate.5

Kahneman and his collaborators have carried out numerous experiments that examined people's determinations of probability and utility. These experiments purport to identify a systematic mismatch between the P . U formula and the ways in which people typically make decisions in the real world. Specifically, the experiments have been interpreted as demonstrating that people systematically err in calculating probability and appraising utility. According to Kahneman and other behavioral economists, these errors manifest people's bounded rationality.6

As far as probability is concerned, people often seem to allow familiar and stereotypical scenarios to override statistical information (pp. 112-13, 119-23, Chapter Twelve). They ignore general statistical information-specifically, they ignore "base rates" (pp. 146-69)-which causes them to underestimate the probability of unfamiliar events (pp. 149-53) and overestimate the probability of scenarios that fall within their experience or easily come to mind, such as natural disasters or startling events that have occurred recently (Chapter Thirteen). In the domain of utility, people fare no better. They irrationally allow their choices to be influenced by the framing of future prospects as either "gains" or "losses" (Chapter Twenty-Six). Specifically, the average person strongly prefers the prospect of not losing a certain amount of money to an equally probable prospect of gaining the same amount of money. 7 This preference explains people's loss aversion8 and their unwillingness to sell property that they already own at what should be an economically attractive price (the "endowment effect").9 Additionally, people's actions are often driven by sunk costs-expenses that have already been incurred, and that an economically rational individual ought to ignore. …

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