Read Online Priceless: The Myth of Fair Value (and How to Take Advantage of It) by William Poundstone - Free Book Online
Authors: William Poundstone
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information collected from distant early warning radar and ships at sea. In those pre-Google days, the volume of real-time information was mesmerizing. Edwards asked the officer escorting him what was done with all that information. His escort pointed to a red telephone, apparently a direct line to the White House. Edwards asked, “Do you think the ratio of input to output information should be like that?”
Edwards had not gained much academic renown by the time he moved to the University of Michigan’s psychology department. “Michiganwas a large department, very tolerant and very open,” psychologist Barbara Tversky explained. Even in that most liberal context, Edwards stood out. He “was nutty—not really socialized.” Two associates recalled that Edwards’s “occasional colorful and forthright behavior” perpetually threatened to derail tenure.
With his free-spirted wife, Ruth (a Ph.D. student of B. F. Skinner’s), Edwards lived in bohemian splendor. At one point the couple inhabited a dusty building behind a garage, in an industrial part of Ann Arbor; at another, a ruinous farmhouse. The Edwardses raised dachshunds, one named Willy (after psychophysicist Wilhelm Wundt, of course). Dinner parties featured “Ruth’s excellent, if often exotic cooking, with the early arrivals required to light dozens of candles placed on every horizontal surface in living and dining rooms.”
Edwards is usually credited as the founder of behavioral decision theory. It was certainly he who lent the nascent field a name, in the form of the title of a 1961 paper. But others were exploring decision making, at Michigan and elsewhere.
Many of the early experiments involved gambling. A researcher needs a way of getting subjects’ attention in a psychological experiment. A small money prize, that might be won or might not, is an effective motivator. Edwards and Michigan colleague Clyde Coombs did experiments in which volunteers had to choose between gambles or assign prices to them. Sarah Lichtenstein, who took her Ph.D. under Edwards, has the impression that Coombs (“a marvelous person”) was not interested in gambling per se. Gambles simply offered a handy way of creating decision problems. Edwards “was actually interested in the economic theories of decision making.”
In deciding how much to pay for a car or whom to marry, there are always trade-offs—a process of “comparing incomparables,” in Coombs’s words. Gambles offer an obvious trade-off between the money to be won and the chance of winning it. So Coombs and Edwards would have volunteers choose between a gamble with a bigger prize and another with a better chance of winning. The psychologists sifted the stated preferences and tried to discern how people decided. A 1960 study by Coombs and D. G. Pruitt found that most of the choices could be explained by simple rules such as “Always choose the bet with the highest payoff for winning.”
Welcome to the world of bounded rationality. Anyone who followed this rule was ignoring the odds—betting on the long shots, no matter what. That policy doesn’t work well at the racetrack, and it’s not much better elsewhere.
Edwards learned poker at the Air Force job and remained an enthusiastic player at Michigan. The game provided some of his experimental supplies. One of Edwards’s best-known experiments involved two backpacks filled with equal numbers of poker chips. One of the backpacks contains mostly red chips—say, 70 percent red and 30 percent white. The other is mostly white chips, with the percentages reversed. You don’t know which backpack is which. Your task is to decide which is the mostly red backpack. To do that, you draw chips one at a time from one backpack. You must estimate the odds as you go. It’s as if you’re a bookmaker and have to quote the current point spread. Edwards had students do that as he carefully kept track of the colors of the chips drawn.
Imagine you’re drawing from
Edwards had not gained much academic renown by the time he moved to the University of Michigan’s psychology department. “Michiganwas a large department, very tolerant and very open,” psychologist Barbara Tversky explained. Even in that most liberal context, Edwards stood out. He “was nutty—not really socialized.” Two associates recalled that Edwards’s “occasional colorful and forthright behavior” perpetually threatened to derail tenure.
With his free-spirted wife, Ruth (a Ph.D. student of B. F. Skinner’s), Edwards lived in bohemian splendor. At one point the couple inhabited a dusty building behind a garage, in an industrial part of Ann Arbor; at another, a ruinous farmhouse. The Edwardses raised dachshunds, one named Willy (after psychophysicist Wilhelm Wundt, of course). Dinner parties featured “Ruth’s excellent, if often exotic cooking, with the early arrivals required to light dozens of candles placed on every horizontal surface in living and dining rooms.”
Edwards is usually credited as the founder of behavioral decision theory. It was certainly he who lent the nascent field a name, in the form of the title of a 1961 paper. But others were exploring decision making, at Michigan and elsewhere.
Many of the early experiments involved gambling. A researcher needs a way of getting subjects’ attention in a psychological experiment. A small money prize, that might be won or might not, is an effective motivator. Edwards and Michigan colleague Clyde Coombs did experiments in which volunteers had to choose between gambles or assign prices to them. Sarah Lichtenstein, who took her Ph.D. under Edwards, has the impression that Coombs (“a marvelous person”) was not interested in gambling per se. Gambles simply offered a handy way of creating decision problems. Edwards “was actually interested in the economic theories of decision making.”
In deciding how much to pay for a car or whom to marry, there are always trade-offs—a process of “comparing incomparables,” in Coombs’s words. Gambles offer an obvious trade-off between the money to be won and the chance of winning it. So Coombs and Edwards would have volunteers choose between a gamble with a bigger prize and another with a better chance of winning. The psychologists sifted the stated preferences and tried to discern how people decided. A 1960 study by Coombs and D. G. Pruitt found that most of the choices could be explained by simple rules such as “Always choose the bet with the highest payoff for winning.”
Welcome to the world of bounded rationality. Anyone who followed this rule was ignoring the odds—betting on the long shots, no matter what. That policy doesn’t work well at the racetrack, and it’s not much better elsewhere.
Edwards learned poker at the Air Force job and remained an enthusiastic player at Michigan. The game provided some of his experimental supplies. One of Edwards’s best-known experiments involved two backpacks filled with equal numbers of poker chips. One of the backpacks contains mostly red chips—say, 70 percent red and 30 percent white. The other is mostly white chips, with the percentages reversed. You don’t know which backpack is which. Your task is to decide which is the mostly red backpack. To do that, you draw chips one at a time from one backpack. You must estimate the odds as you go. It’s as if you’re a bookmaker and have to quote the current point spread. Edwards had students do that as he carefully kept track of the colors of the chips drawn.
Imagine you’re drawing from
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