Decision (including errors of reasoning and judgment) and conflict of objectives
In general, a decision can be understood as a choice between at least two alternatives, taking into account objectives. Economic specifics of decisions result from the scarcity problem, so that decisions are to be made as rationally as possible (normative component of decision theory) with the aim of maximising benefits or profits, high efficiency or the best possible cost-benefit ratio. A rational decision therefore results in the selection of the best possible (benefit-maximizing) alternative.
A particular challenge is the handling of several objectives, which often cannot be achieved in full simultaneously. Such conflicting objectives occur in most individual decisions (for example, when choosing a dwelling between costs, location and size or when making an investment decision where a balance has to be struck between return and risk), but also in the context of economic policy (for example, additional investment vs. tax cuts).
According to economic behaviour theory or the rational choice approach, human behaviour and thus decisions are dependent on two main factors: firstly, the preferences of a decision-maker, from which the benefit can be derived, and secondly, the restrictions (e.g. scarce financial resources, time, know-how) to which he is bound. Against this background he rationally makes a benefit-maximizing decision. The cost-benefit ratio and opportunity costs must be taken into account. Although these complexity reducing assumptions are helpful for the analysis of several abstract economic phenomena (e.g. demand behaviour for goods), they are only of limited use for many life-world decision situations. For this purpose, further aspects of decisions must be taken into account:
- Decision-makers do not necessarily strive to maximize self-interest, but may feel bound by social conventions and ethical norms such as responsibility towards others, which is also an objective of economic education.
- Many decisions are made in the presence of incomplete information, either because not all relevant information is available or because obtaining it would involve a great deal of effort (transaction costs).
- In connection with this is the uncertainty or the problem of risk that is unavoidable in many situations. Numerous questions cannot be calculated through completely because not all influencing factors and mechanisms of action can be determined or cannot be (unambiguously) calculated due to their stochastic character or complexity.
- Short and long-term effects of a decision can also be counterproductive.
- The information processing capacity of decision makers is limited.
- According to the findings of behavioural economics and psychology, many people are subject to numerous errors of thought and perception (descriptive component of decision theory), which can lead to suboptimal results in economically influenced situations. Some examples:
- Availability bias/availability heuristics/availability bias: Decisions are made on the basis of information that is easy to obtain or remember. Therefore, ideas about facts (and related decisions) are often not developed on the basis of information that may be readily available, but rather on the basis of easily available but possibly wrong or insufficient information, own experiences or media reports. As a result, decisions are made on the basis of incorrect information and incorrect risk assessments, e.g. buying very risky financial products, avoiding stocks or flights.
- Neglect of Probability: Especially small risks are either completely ignored or greatly overestimated. People react to the extent of an event, but hardly to its probability. This leads, for example, to too many insurance contracts being concluded or to insurance contracts that are hardly recommendable.
- Player error: The assumption that a random event becomes more probable the longer it has not occurred and vice versa. For example, the assumption that in roulette it must soon appear red if black always came up in the last ten games (if the gaming table is not manipulated) or the assumption that a share price must fall just because it has risen for a long time.
- Outcome Bias: The quality of a decision is judged by its outcome rather than by the decision itself. In the case of randomly influenced results, this can lead to bad decisions/decision-makers/strategies that were successful due to unlikely events being positively evaluated and used again. For example, almost all investment fund providers have many funds on offer, some of which can inevitably show a very positive performance. These are then advertised with reference to past performance. However, this does not initially say anything about the quality of the fund managers and future performance.
- Loss aversion: Losses are emotionally weighted much higher than gains. Therefore, theoretically reasonable risks are not taken. As a consequence, there is over-insurance, preference is given to supposedly safe forms of investment despite an unfavourable risk/return ratio, or shares are held on to below cost price.
- Endowment or possession effect: people value a good more when they own it. This leads, among other things, to sellers estimating the value of their house or car significantly above the usual market price, making it difficult to find a buyer.
- Mental Accounting/Mental Accounting: Classification of financial transactions into different 'mental accounts', which are treated differently. This can lead to wrong decisions being made. Thus, the handling of money can differ depending on whether it is mentally "hard-earned" in the account or "won the lottery".
- Sunk-Cost-Fallacy: Costs already incurred lead to something to be continued, although this would not make sense from an objective point of view (for example, investors who base their decision to sell a share on its cost price).
- Framing: The formulation or framing of a message influences the response to it by focusing on a particular aspect of the situation. For example, the statement 'You have a 50% chance of doubling your bet in Roulette' is more likely to lead to gambling than 'You lose in Roulette'.
- Contrast effect: people have difficulties with absolute assessments and instead make relative comparisons. As a result, something appears more beautiful, cheaper etc. when compared with something uglier or more expensive. For example, a product appears cheaper if it has been visibly reduced than the same product that had the cheaper price from the beginning.
- Social Proof/Herdrive: The assumption that something is right when many people think it is right. This is a typical cause of bubbles and panic in the stock market.
- Reciprocity: People have an evolutionary or genetic need for mutual balance. When you receive something, you want to give something back. This can be misused for manipulation: When you are given something as a gift, you feel the need for something in return, which you may not want to give at all, but which you feel obligated to do. Calls for donations are often accompanied by small gifts such as postcards, which leads to a demonstrably larger amount of donations. The same mechanism is partly based on corruption when a decision-maker receives or accepts gifts and therefore feels obliged to give something in return.
Since decisions have to be made in almost all economically influenced life situations (for example, decisions on consumer goods, credit offers, investment opportunities, insurance, professions or a political party in elections) and sometimes have considerable consequences, the development of decision-making competence is a central goal of economic education. Decision-making competence includes ...
- to analyse the situational conditions relevant for decision-making (for example: Who has which interests/preferences? Which goals are being pursued? What networking effects are there?).
- to research, evaluate and structure information relevant to decision-making and, on this basis
- evaluate alternatives, taking into account conflicting objectives, short and long-term effects, side effects, probabilities/risks and effects on third parties This requires
- Ability to use decision support tools (e.g. utility analysis, break-even analysis, comparative cost accounting, cost and performance accounting, ratios, static and dynamic models to simulate the consequences of different decisions, scenario technique).
- to know typical errors of thought and judgment and to be able to avoid them.
- to assess when time-saving and effort-reducing heuristics and rules of behaviour (e.g. imitation of the behaviour of others) can be useful instead of the costly, rational procedures.
In this respect, decisions are relevant for almost all topics of business education. They are an integral part of problem and life situation oriented teaching.