A Little Psychology

In order to understand how the world works, we have to understand how people think. That’s a tall order, so the sections below focus on a few things that I’ve found particularly useful. People Don’t Maximize Utility In 1971, Daniel Kahneman and Amos Tversky ran a simple experiment. They told participants that a disease was expected to kill 600 people and asked them to choose between two public health programs. Program A would save exactly 200 people. Program B had a one-in-three chance of saving all 600 and a two-in-three chance of saving none. Most people chose A, i.e., they preferred the certain outcome. Then Kahneman and Tversky rephrased the choice. Program C would result in exactly 400 deaths. Program D had a one-in-three chance that nobody would die and a two-in-three chance that all 600 would die. Statistically, the two programs are identical, but this time, most people chose D. Nothing changed except how the outcomes were described. Classical economics assumes that people are…