Let’s consider high probability events those with probably is above about 75%. Such event “should happen” even though there is a chance they might not.
People become more conservative when odds are in favor
An event that should happen with an objective 90% probability might seem subjectively like only a 75% chance. One event that should happen with 99% probability might seem subjectively like about 95%. For many decisions this implies that people become more conservative than they should when the odds are in their favor.
In civil court cases plaintiffs might settle for a lesser amount even though they have a very strong case. They underestimate their chances of winning. Gamblers who bet on horse races tend to, in the aggregate, bet too much on low probability long-shots and too little on high probability favorites and as will see much later in this course this phenomena influences our medical decision-making as well. People often seek out unnecessary treatments to deal with the medical challenge that has a good prognosis.
The prospect theory
These three parts “could, might and should’ combine into the probability weighting function of prospect theory. We overvalue low probability events that could happen we undervalue high probability events that should happen. We are largely indifferent to the probabilities of events in the middle. Our subjective sense of probability doesn’t match the objective reality.
Our judgments of probability are not accurate but are systematically biased. They are biased because we don’t have access to the true probabilities. We don’t know whether we’ll need insurance we don’t know the probability of violent crime in our area. We can’t just look up those probabilities from some database in our brains
instead we estimate those probabilities when we need to reconstruct stories about what could happen base our memories of past history and our reasoning about similar events.
Can we eliminate these biases? No! These biases do not disappear once we know about them. You can’t suddenly start seeing 45% and 55% is very different in probability or start thinking about a 99% chance of success without being concerned about that 1% chance of failure. But what you can do is modify how you approach a decision changing the very way in which you construct probabilities.
Let me give you two tools for changing how you deal with probabilities: first use the availability heuristic to your advantage. Remember that I stated that people tend to overestimate the likelihood of some event when it was relatively easy to create vivid stories.
So if you want to reduce the chance that you will be influenced too much by a rare event think about that event in a way that makes it less vivid. Distance yourself from that event imagine that you are advising someone else. What would you tell them? Would you advise your friend to buy insurance for his smart phone or would he be better served by passing given the high cost of insurance and the low probability of needing replacement?
Would you tell your friend to avoid a camping trip in the woods because of a very rare chance of an undetected tick bite? By dampening down our internal storyteller we can improve the accuracy of our judgments for low and high probability events, but what about that large range in the middle: events that might happen or they might not.
The problem for those events is not inaccuracy per se but in sensitivity to changes in probability. What could make someone think that the difference between 45% and 50% matters? To deal with in life events use a second tool think about probability in terms of frequency.