THE WAY WE THINK

Kahneman’s contribution to economics has been in questioning the assumption that all economic agents are rational

CONSIDER THE FOLLOWING riddle: “A bat and a ball together cost $1.10. The bat costs a dollar more than the ball. How much does the ball cost?” Think for a moment but go easy on yourself if your answer was 10 cents. Of course, it is wrong. If the ball was 10 cents the total cost of bat and ball would be $1.20. The correct answer is 5 cents. But the point of the riddle is to underscore that most people had a number in their mind and that number was 10 cents. According to psychologist Daniel Kahneman, who died on March 27 at the age of 90, this example showed how people often make decisions in a hurry, without checking, and are also quite confident about it.

Kahneman was an Israeli-american psychologist who revolutionised the world with his experiments and insights — so much so that even though he was not an economist, he went on to win the Nobel prize in economics in 2002 “for having integrated insights from psychological research into economic science, especially concerning human judgment and decision-making under uncertainty”. Kahneman wrote several seminal books and papers. The most-widely read was titled “Thinking, fast and slow”. The book explained how people think, the errors they make and why, the biases they have and the fallacies that often cloud their decisions. His latest book, “Noise”, focused on the unwanted variability, as opposed to bias, in judgments that should be identical.

Kahneman’s lasting contribution to economics has been to question the dominance of the assumption that all economic agents are “rational”. Through his experiments he underscored the flaws in such assumptions. In doing so, he helped establish behavioural economics as a field and many such as Richard Thaler (winner of the 2017 Nobel prize in economics and most commonly associated with his book “Nudge”) have further advanced the use of such psychological insights in economics. At a macro level, however, even Kahneman knew that society rewards overconfidence. “We want our leaders to be overconfident. If they told us the truth about the uncertainty, we would discard them in favour of other leaders who give an impression that they know what they are doing”.