[MUSIC] As a manger or leader is a good idea to understand how expected utility theory works. There are at least two reasons for this. The first is that it makes you aware of the various pieces of information we have to work with when we make decisions. We're so used to making choices that we often process all this information with little or no thought or reflection about it at all. The other reason for knowing about expected utility theory is that it draws our attention to all the information that we should ideally use when we make decisions. Understanding what we should do when we make choices gives us some understanding of what we actually do when we choose. This distinction is an important one in decision making. Theories about how we should make decisions are called normative theories, whereas theories about how we actually do make decisions are called descriptive theories. Expected utility theory, the theory that we have looked at so far is now genuinely considered a normative theory. It is an account of how we should make decisions not how we actually make them. So if expected utility theory doesn't explain how we generally made decisions, how do we generally made them. Perhaps, the first researcher to suggest that the way we make decisions isn't with the very rational, thara and all knowing process of expect the utility theory but my something much more rough and ready was Herbert Simon. Simon was an administrative economist, a psychologist, and a computer scientist, amongst other things, and in 1978 he won an Nobel Prize in economics for his work. One of the reasons that Simon's ideas made a really big impact was that, in the 1970s, Economists in economic theory generally assume that human decision making is rational. Simon suggested otherwise. He claimed that most decision making is less than rational. The decisions made in organizations, he said, conformed poorly with those predicted by theories of rational choice. That is theories like Pascal's and Bernoulli's Expected Utility Theory. Our decision making, said Simon, is constrained by bounded rationality and we make decisions not by maximizing, but by satisficing. When Simon says that our decision making is constrained by bounded rationality, he means that it is rational but only up to a point. When he says we make decisions by satisficing rather than maximizing, he essentially means that we make decisions which are good enough, which will do rather than ones which are ideal. Rather than trying to make perfect decisions at work as would be implied by expected utility theory, we make decisions which will get us by. The word satisfies is really a mixture of satisfy and suffice. So we make decisions which will suffice, which will be satisfactory enough to get us along, which we think will be good enough. Rather than decisions which involve comprehensively and completely processing all the information relevant to a decision in an entirely rational manner. Simon's work opened the door to the idea, that decision making in organizations and elsewhere, is generally flawed. But what Simon didn't do, was explain the process by which we decide. If we don't make decisions in the comprehensive and rational way proposed in expected utility theory, then how do we do it? The question of how we make decisions was taken up by psychologists, the most famous of these being Daniel Kahneman and Amos Tversky. With a series of often quite simple but ingenious experiments, Kahneman and Tversky began to investigate how leaders, managers and everyone else typically make choices. We'll look at two of these experiments in a moment, but before we do, it is useful to look at the two psychological systems by which it is now genuinely accepted that we make choices. These are known not very imaginatively as System 1, and System 2. Perhaps, the best way to understand what we mean by System 1 and System 2 thinking and choice is with an example. Look at this image. What are you feeling? What are you thinking? Now, look at this second image. What are you feeling and thinking now? Here's the question, how quickly did you react to these two images. Did it take you a while to decide how to feel and think about them? Did you have to consciously workout what your emotional reaction would be? Did you have to use effort to decide how to feel? The answer to all these questions is almost certainly that you reacted very quickly almost instantly to the images that you didn't have to consciously work out how to think and how to feel about them. And that you didn't have to make any effort in deciding what you thought and felt, it just happened. Now, consider this problem, 16 x 23, have a go at working out the answer. What is 16 x 23? Well, here are the same questions about the way you are dealing with this. Did it take you a while to work out the answer, or did you know it instantly? Could you work out the answer without conscious thought? Did you have to consciously pay attention and make an effort in order to come up with an answer? Here, I expect the answer is very different to the one you gave about the images of the woman with a child and the man poking a finger about you. This time, it took you a while to work things out. And you had to do it consciously. And it took deliberate attention and effort. This illustrates the two ways that we think our make choices. When you reacted to the images, you were using System 1 thought. System 1 is fast, unconscious, effortless, and enables you to process lots of pieces of information simultaneously. However, when you multiplied 16 by 23, you used System 2. System 2 is slower, it involves conscious thought. It often requires effort, and with it, the amount of information you can process at any one time is quite restricted. [MUSIC]
