Thinking like an economist 23: Agonising decisions
Decisions with important consequences can sometimes be 'agonising'. We can go round and round in our minds, struggling to choose between two finely balanced options. Fear of making the wrong choice stops us from settling on a decision. Decision analysis provides an insight that can help us to break out of this painful cycle of indecision.
The real estate investment I discussed in PD#70 is a good example of an agonising decision. I could invest in a house, but face the risk that the market would subsequently fall, or I could invest in something other than a house and face the risk that the housing market would subsequently rise. Owning a house in Perth could be convenient to us as a family in the future, but finding and dealing with tenants would be inconvenient in the short term. Overall, the best choice was not at all obvious. I took longer than I should have to make a decision to buy, and, in retrospect, lost a substantial amount because the market rose while I dithered.
But that is all very well 'in retrospect'. If I'd known that in advance, the decision wouldn't have been agonising. The essence of an agonising decision is that, in prospect, the options appear finely balanced and difficult to separate.
'Decision analysis' can help you break out of this impasse, although perhaps not quite in the way you might expect.
Decision analysis is a formal approach in which you systematically weigh up your decision options, their possible consequences, the probabilities of those consequences, and how important the consequences are to you (Anderson et al., 1977). The suggested criterion for choice is the option that maximises the expected value of your objective, where I mean 'expected' in the statistical sense of a weighted average.
I remember reading about one of the leading figures in decision analysis who was agonising over a big decision affecting his personal life. One of his students asked him, 'Why don't you use decision analysis to help you?' His response was something like, 'Don't be silly! This is far too important for that.'
This says something about the importance of emotion and intuition in decision making, but I don't think decision analysis is as unhelpful as that, even for the most emotion-charged decisions. The reason is that it provides a powerful, though simple, insight that I, at least, find very helpful.
The insight is that it doesn't matter. If you weigh up your decision options, their possible consequences, the probabilities, and so on, and find that in your personal circumstances and given your personal perceptions and preferences, the options are finely balanced, then it doesn't matter which you choose.
In future, when you look back at the decision and consider it in retrospect, your current choice will matter, but in prospect, the options are finely balanced, so either will give almost the same expected payoff.
So don't agonise. If you can't collect additional information to help break the deadlock, then use any criterion you like to select a decision option. Toss a coin. Choose the most adventurous option. Choose the one your partner would prefer. Anything at all. Just choose one, without agonising. Agonising cannot improve your decision, because, whether you swap from option A to B or back again, the expected gain or loss is minimal. And in the short term, agonising is painful, so don't suffer needlessly.
David Pannell, The University of Western Australia, David.Pannell@uwa.edu.au
Anderson, J.R., Dillon, J.L. and Hardaker, J.B. (1977). Agricultural Decision Analysis. Ames: Iowa State University Press.
p.s. email from Ben White, 12 April 2006.
In financial economics they put a lot of effort into assessing what is the worst that can happen, so hard decisions might boil down to ‘can I cope with the worst that can happen’ in pursuit of a level of expected income. If the answer is ‘no’ then reduce the downside risk. Your housing decision could be assessed using historical data on house price volatility and adjusting your portfolio between the bank, shares and property until the downside risk is acceptable.
DP: I agree, there is a lot you could do to make a more informed choice. But even if you do, you could still end up with a very unclear choice about which option is best, if two options end up being about as attractive as each other. My suggestion above kicks in after you've done as much analysis as you're going to do.
Pannell Discussions are brief pieces on issues and ideas in economics, science, the environment, natural resource management, politics, agriculture and whatever else.
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