Judgments, Decisions and the Interplay with Systems

Systems are made up of many different variables, not the least of which are people and the decisions they make. People are involved in energy systems as policymakers, business executives, investors and private citizens. Unfortunately, as we will discuss, the mind has inherent biases that can skew humans to have poor judgment; and bad judgment is a harbinger of a bad decision.

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People’s judgments and subsequent decisions impact systems in two ways. First, judgments by people are felt as key variables within existing system structures. For example, expectations about future profitability of new capacity are often a key judgment which is made as executives decide whether and how much to build.

 

People’s judgments can also be a determinant of the structure of the system itself. For example, the policymakers that decided to regulate emissions of acid rain judged that something needed to be done and acted. Regulations like these create new sets of rules and variables (in this case, the price of emissions) and by doing so create a new system structure.

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How is Judgment Formed? Understanding Your Two Minds

We can all remember times that our judgment seemed logical, analytical and effective. Data is gathered, analysis is performed, judgment formed, and a reasonable decision is made. However, if we conjure up a bit of self-awareness, there are other times where we were considerably less thoughtful. Our judgments seem rushed, based on spurious information, or were formed without us really “thinking.” The result is often a bad decision that we look back on with some degree of embarrassment.

 

Evaluating how judgment forms is more nuanced than analyzing system structures. Systems structures can be thought through, evaluated, and debated with a certain level of facts and logic. Judgment is more difficult to evaluate with such precision. Yet, most people would agree that there are two aspects of one’s mind at work – one that appears more thoughtful at times and one a bit less so.

 

This reasonably obviously point has had some considerable debate among economists. Much of classical economic theory portends that individuals are non-emotional mathematically efficient decision-makers. People carefully assess options, obtain relevant data, analyze it and make the economically most rational choice. Twenty years or so ago, another camp in economics – those living in the real world and possessing an understanding of psychology and marketing – began to question these views. These so-called behavioral economists contend that there are a host of reasons, often psychological or behavioral in nature, why individuals do not always make the rational mathematically optimal choice. Through considerable research, they have shown that people possess biases in forming quality judgments.

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There is no reason to overcomplicate the issue. The mind forms judgments, sometimes more rationally and sometimes less so. We will call Mind 1 the rational one, and Mind 2 the behavioral one. At times, the rational mind dominates and, at times, the behavioral mind dominates. Most times, it is very hard to differentiate as both minds influence judgment simultaneously. When the behavioral mind dominates, it does not mean that the outcome is necessarily a bad decision, but there are clear risks of biases entering judgment due to the influence of Mind 2.

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Two behavioral economics’ pioneers have described similar concepts. Richard Thaler in his book, Misbehaving, uses the terms “Econs” and “Humans.” “Econs” are those mathematically optimizing perfect decision-makers often described by classical economists, and “humans” are, well, normal people. Daniel Kahneman in his book, Thinking Fast and Slow, describes “System 1” and “System 2.” System 1 is the automatic part of the mind that is constantly forming judgments often unbeknownst to us. System 2 is more reflective and controlled thinking. The particular words used to describe these aspects of judgment formation are not nearly as important as recognition that judgment can be influenced in two distinct manners.

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Framing the Types of Judgment Biases

There has been considerable research on the biases that creep into our minds and skew judgment. Richard Cialdini, a psychology professor at Arizona State University, wrote the highly acclaimed book called, Influence, in 1984 which showed great examples of how we are easily influenced in irrational ways. Paco Underhill, an anthropologist by training, highlighted how people make purchasing decisions in his work, Why We Buy: The Science of Shopping (1999), which is standard reading for many in the retail world. Amos Tversky and Daniel Kahneman, psychologists by training, pioneered research in behavioral economics in the 1970s, receiving a Nobel Prize in 2002. Richard Thaler, an economics professor at the University of Chicago, performed some of the most influential research showing the importance of psychology on decision-making. There are countless others and the field continues to grow.

 

This research has identified countless biases, by some measures over 100, that cloud good judgment. While comprehensive, a list of 100 discrete biases is not altogether helpful. Therefore, I have segregated those most relevant to our research into the following four groups (See Figure 37):

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1. Data or Probability Biases: Biases in the way we gather or interpret data or probabilities

2. Calculation or Decision Biases: Biases resulting in illogical calculations or decisions

3. Social Biases: Biases driven by inherent social tendencies or needs

4. Memory Biases: Biases that hinder learning and improvement

 

The list below is by no means comprehensive, but simply the most common biases emerged during the research we conducted. Many of these biases interact with one another so it is important to not always think that each bias is always a discrete event. The following four sections discuss each of the biases in some detail. The descriptions are fairly short as the crux of this book is about applying these concepts to energy versus proving their existence which has been done via significant academic research already.

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