Our society is built on the premise that human beings are more or less rational. We trust that our leaders, judges, scientists, and other experts are making fair and unbiased decisions, and that we ourselves are seeing the world as it is and making the best choices we can.If only that were true!

Human Beings Are Rational, Right?

Research has shown that when taking on risky projects or investments, decision-makers often fall victim to what Kahneman calls the “planning fallacy.” This is our tendency to make optimistic predictions based on what our fast-acting System 1 mind hopes will happen, rather than a careful analysis of what is likely to happen based on statistics or experience, as analyzed by System 2. This fallacy impacts both corporate and individual behavior, as we reliably overestimate benefits and underestimate costs.

An Example Of Distortion: The Planning Fallacy

“Reference dependence,” is what Kahneman calls our tendency to perceive the value of things and experiences relative to some status quo that we hold in mind—whether it’s our memory of how much a thing used to cost, or our neighbor’s fancy car that influences what kind of car we think we “should” have.

“Reference Dependence”

You don’t have one mind. When it comes to thinking, Daniel Kahneman argues, you have two. While they go by many names, Kahneman prefers the terms System 1 and System 2.

Like It Or Not, You Are Always Of Two Minds. 

Put structures in place around you that make decision-making more deliberative. For example, Kahneman recommends leaders adopt checklists, which help avoid oversights and encourage a culture of slow thinking.

Structures Make For Deliberation

Buying an expensive luxury item may give you a lot of actual joy in the moment. But with hindsight, the cost of the purchase may weigh on you, and you may decide it wasn’t worth it. So the next time you have a purchase to make, do you optimize for the in-the-moment experience, or for the memory of that experience, which is what you’ll retain over the long term? It’s not always easy to decide, because your two selves have different priorities.

The “Experiencing Self” And The “Remembering Self”

This division of labor is highly efficient. For a mind that is constantly being bombarded with stimuli, it keeps effort to a minimum. System 1 can take care of a lot of basic tasks without any input from System 2. It is the one that works most of the time because System 1, despite being automatic and intuitive, is pretty good at modeling familiar situations and reacting to challenges.

The Division Of Labour

The planning fallacy is just one of dozens of mental distortions that Kahneman and his fellow researchers have identified, a devastating critique of the rational choice theory favored by many economists. By learning about these cognitive biases, we’re more likely to avoid their false conclusions and see the world more accurately.

Using Our Mental Distortions To Our Benefit

Broadly speaking, there are three stages to making a decision:<ul><li>Framing the problem</li><li>Collecting the relevant data</li><li>Reflecting on and reviewing the information</li></ul>According to Kahneman, paying careful attention to each stage of the process will result in improved decision-making. Whether it’s planning corporate strategy or making an individual choice, we think best when we think slower, when both System 1 and System 2 are allowed to do their jobs.

The 3 Stages Of Making A Decision

System 1 thinks quickly and automatically, with little to no effort and no sense of voluntary control. System 1 lets you immediately recognize that one person is farther away than another, for example, or lets you solve 2 + 2 without having to think about it.

The 2-System Mind: System 1 Of 2

The “experiencing self” is rooted in System 1, which favors short periods of intense pleasure and dreads sharp pains. The System 2 “remembering self” tells a story about that experience, and that story changes over time. For example, patients undergoing brief but painful medical procedures report suffering more than patients who had longer procedures where the pain was initially just as great but lessened over time. Even though the second set of patients experienced more total pain, the way the pain was distributed over time made them remember the procedure more favorably.

Systems And Selves

In fact, human thinking is riddled with biases, oversimplifications, and distortions. And these mistakes aren’t random, either. In Thinking, Fast and Slow , Nobel Prize-winning economist and psychologist Daniel Kahneman attempts to uncover the patterns of error in human judgement, and suggests ways we can fine-tune our thinking to make better decisions and see the world more clearly.

No, Human Beings Are Not Really Rational

System 2 operates slowly, calculating and reasoning. It’s what we think of as our conscious, deliberate mind. System 2 is what lets you calculate just how far away that person is, or helps you solve a harder math problem like 16 x 43.

The 2-System Mind: System 2 Of 2

System 1 is prone to biases, cognitive illusions, and overconfidence. We often fail to recognize these errors because they happen so quickly, before our conscious mind has even kicked into gear. By better understanding our two-system mind and how it operates, we can avoid mistakes in reasoning and make better decisions.

Mind 1 Makes Mistakes

You may think that your experiences (“I’m having fun!”) and your memories (“That was fun!”) are closely connected. But Daniel Kahneman points out that they can diverge drastically, and that has implications for the choices you make.

Experience And Memory Are In Conflict

So, our two-system mind is subject to all sorts of cognitive errors. What can we do about it? How can we more reliably make good decisions?First, recognize when your automatic, System 1 thinking is leading you astray, then slow down and get reinforcement from System 2. While this can be very hard to do in the moment, knowing about the existence of cognitive biases and fallacies makes it more likely you’ll spot them. It’s also a lot easier to recognize when others are wandering into a cognitive minefield. Giving and getting feedback from people around you makes avoiding errors more likely.

To Think Smart, Think Slow

First published by Kahneman and his longtime collaborator Amos Tversky in 1979, prospect theory is a model of decision-making behavior informed by Systems 1 and 2. It was cited in the 2002 decision to award Kahneman the Nobel Prize in Economics.A key aspect of the theory is loss aversion . This is the observation that the pain people experience from losing $50 is much more intense than the joy they experience from earning $50. In other words, we’ll do more to avoid a loss than we will to achieve a gain.

Losses Loom Larger Than Gains

5 Key Insights from Nobel Prize winner Daniel Kahneman's Thinking, Fast and Slow.

“Reference Dependence”

Similar ideas to “Reference Dependence”

Biases That Influence Us Subconsciously

Finding A Universal Definition