Session 2: Decision-making and interaction: Classical and bounded rational

Question 1

Classical architecture

Answer 1

The classical model assumes decision makers can make decisions and choices perfectly (no bounded rationality), and instantaneously (no process)

Question 2

Classifying organization theories

Answer 2

See picture in notes:

(Complete rationality, opportunistic behavior): Complete contracts

(Complete rationality, self-interested behavior): General equilibrium

(Limited rationality, opportunistic behavior): Incomplete contracts

(Limited rationality, self-interested behavior): -

(Procedural rationality, all behaviors): Evolutionary approaches

(complete/limited rationality, idealistic behavior): System of atrributes Team theory

Question 3

Degree of rationality

Answer 3

The ratio between cognitive capacities and the complexity of the problem. Equals one when the is complete rationality

Question 4

Efficient equilibrium

Answer 4

The available information determines what can be achieved. An equilibrium with asymmetric information often differs from the first best equilibrium in a situation with perfect information (Called second-best efficient)

Question 5

Nash equilibrium

Answer 5

A payoff maximising stragety for each player. No player will be better off from changing strategy.
There can be more Nash equilibrium, but only one sub game euqilibrium.

Question 6

How to sustain corporation

Answer 6

Between firms:
* Through contracts specifying who has to pay what in exchange of specific actions.
* Implicit contracts: Decent behavior due to risk of bad reputation.
* Mediators, arbitrators
* Repeated interactions

Inside firms:
* Reputation of/between different employees
* Internal contracts from division to division
* Culture and repeated interaction
* Employment law
* Unions, mediators, etc.

Question 7

BESHEARS & GINO (2015): System 1 and system 2

Answer 7

System 1 thinking: is automatic, instinctive, and emotional. It relies on mental shortcuts that generate intuitive answers to problems as they arise.

System 2 thinking: is slow, logical, and deliberate.

Question 8

BESHEARS & GINO (2015): Two main causes of poor decision-making

Answer 8

Insufficient motivation and cognitive biases.

Question 9

BESHEARS & GINO (2015): Common biases that affect business decisions

Answer 9

Action-oriented biases
1. Excessive optimism (overestimate p (positive events), underestimate p(negative events))
2. Self-serving biases (we overestimate our skill level relative to others, how much we contributed to joint efforts and our contribution to positive outcomes).

Biases related to perceiving, judging alternatives
3. Confirmation bias (place too much weight on evidence consistent with favored belief)
4. Groupthink (conformity‐seeking makes us disregard alternatives)
5. Knowledge-biases (we assume others know what we do)

Framing of alternatives
6. Loss aversion (losses are felt more acutely than gains of the same amount (reinforces risk‐aversion)
7. Escalation of commitment (investing additional resources in an apparently losing proposition b/c of what we already invested)

Stability biases
8. Status quo bias
9. Present bias (we value immediate rewards very highly, undervalue long‐term gains
10. The endowment effect (we ascribe more value to things when we own them).