Animal Spirits and Irrationalities

It is found in human psychology and several books I have read that people have what is called ‘cognitive biases’ which causes them to make choices which are not in their best interests. It is a product of evolution.

Deviations From ‘Rational Economic Man’

Heuristics: People like whats familiar, and will try a rule of thumb which they have followed for a long time, even though in doing so they expose themselves to a serious loss.

Framing: The power of association with certain products as being positive and negative through experience means that people will avoid a certain course of action due to their thoughts of it, even though it may seem of advantage.

Loss Aversion: One of the most obvious behaviors is that people are willing to stake small consistent losses in the hope of a very large and very unlikely payoff, hence why lotteries are so popular. There is also an unwillingness to risk a very large and improbable loss in return for small consistent gains. Even if both are aligned to payoff the same over time, people choose the first option.

It has been concluded that the pain of loss is twice as intense as the pleasure of an equal gain. For this reason, we are geared towards a loss averse mind.

Gamblers Fallacy is that when a certain outcome has repeated itself, the other outcome is inevitable and it’s probability increases by the law of averages. This can go down to the likelihood of heads turning next increasing when tails has precended for the last 5 times, even though it remains 50/50.

Social Proof or herd behavior is the tendency to follow the crowd, even if the action is irrational, due to the sense of security in numbers. The behavior is evident in asset bubbles and purchasing patterns ‘keeping up with the Jones’s’.

Confidence can vary extremely on ones perception of how likely a certain outcome is. People are subject to wild swings in optimism bordering on the unrealistic, or not taking rational choices due to swings to pessimism.

Fading is where the significance of an important event fades over time, often leading to people taking more risks to a certain loss the more time has passed since the last, after being very cautious soon after.

Hindsight Bias is where people claim to be able to forecast the uncertain after looking back in history to see the events leading up to past unexpected outcomes. This is strongly relted to confidence in it’s excess.

The Zero Sum Game Fallacy we have all had experience of this, for instance, have you ever met someone with the mentality that if a person is wealthy they must have accumulated it by swindling others, or rather they would feel guilty holding wealth as they are depriving others from holding it?

This is a very common fallacy in everyday life, and prevailed just as above but internationally¬†in political decision making in the middle ages with mercantalism. Also it is the same mistake people make by ‘stomping on a colleagues throat’ to get a promotion; people subject to this fallacy are not usually people ou want to associate with.


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