Decision Psychology

System 1 is fast, automatic, emotional, associative. It operates effortlessly and almost beyond our control. It answers the question “2+2?” instantly. It assesses threats before we even consciously perceive the situation.

System 2 is slow, reflective, logical, requires effort and attention. It handles “17×24?”, analyzes complex arguments, manages behavior in unfamiliar situations.

Most of our decisions are made by System 1, while System 2 merely “rationalizes” them after the fact. We are convinced that we are reasoning—but in reality, we are reacting to emotions, images, and heuristics.

System 1 was shaped by millions of years of evolution for survival in a simple environment. It poorly handles:

Classical economics assumes symmetry: a loss of $100 “cancels out” a gain of $100. Kahneman and Tversky refuted this experimentally.

Loss Aversion: the pain from losing $100 is approximately twice as strong as the joy from gaining $100. This is not just a subjective feeling—it is a neurobiological fact: losses activate regions of the brain associated with physical pain.

1. Asymmetry of losses and gains: losses cause more pain than equal gains bring joy.

2. Diminishing sensitivity: the difference between $0 and $100 is felt more acutely than between $900 and $1000. We are more sensitive to changes near the reference point.

Cognitive biases are systematic errors in judgments that arise from simplified patterns of thinking (heuristics). They are predictable and universal: all people are subject to them regardless of intelligence.

Anchoring: the first number heard becomes an “anchor” for all subsequent estimates. The first price mentioned in negotiations establishes the discussion range.

Confirmation Bias: we seek information that confirms an already formed opinion and ignore information that contradicts it. Managers in love with their own idea fail to notice red flags.

Availability Heuristic: the probability of an event is assessed by how easily its examples come to mind. After an air crash, people overestimate the risk of flying.

Heuristics are mental shortcuts that allow us to make quick decisions under incomplete information. They are evolutionarily justified: in simple environments, they yield good results. In complex, unusual situations—they lead to systematic errors.

Representativeness heuristic: we estimate probability based on how much an object “resembles” a prototype. “A shy person who loves books—more likely a librarian or a farmer?” Most say “librarian,” ignoring that there are thousands of times more farmers.

Availability heuristic: we estimate the probability of an event by how easily examples come to mind. Events that the media often report on (terrorist attacks, plane crashes) seem more likely than they really are.

Anchoring and adjustment heuristic: the starting point influences the final assessment. If you ask “is the population of Turkey more or less than 35 million?”, answers will be lower than if the anchor had been 100 million.

Richard Thaler and Cass Sunstein proposed the concept of “nudge”: changing the choice architecture—the design of the environment in which a decision is made—in such a way as to encourage desirable behavior without restricting freedom of choice or using material incentives.

The key principle: do not change the options—change their presentation and order.

Default: most people choose the default option. Pension programs with automatic enrollment (opt-out) result in 90%+ participation versus 60% with opt-in. The default is the most powerful tool of the choice architect.

Order: an option listed first or last is chosen more frequently. Position on a menu, order of candidates on a list influence outcomes.

Definitions

Prefrontal cortex

— the center of System 2, logic, and planning — temporarily "shuts down" under high stress. Control shifts to the amygdala (the center of emotional reactions). This is useful when you need to run from a lion. It is destructive in negotiations, crisi...

When the brain perceives a threat, the "fight or flight" response is triggered: the adrenal glands release cortisol and adrenaline. This narrows the field of attention (tunnel vision), speeds up reaction, but worsens analytical thinking.

Prefrontal cortex — the center of System 2, logic, and planning — temporarily "shuts down" under high stress. Control shifts to the amygdala (the center of emotional reactions). This is useful when you need to run from a lion. It is destructive in negotiations, crisis management, and investment d...

Choice reduction: under stress, people see fewer options and quickly move to the first acceptable one (satisficing instead of optimizing).

Time horizon: stress shifts focus to immediate relief. Long-term consequences are underestimated.

Gary Klein and other researchers have shown: in real crises (fires, military operations, medicine), experienced professionals rarely weigh options methodically. They instantly recognize the pattern of the situation and act based on the “best option”. And they act successfully.

This is the Recognition-Primed Decision (RPD) Model: intuition as pattern recognition, accumulated from thousands of cases. This is not irrationality—it is compressed experience.

Kahneman identified two conditions for good intuition: 1. Regular environment: there are statistical regularities that can genuinely be learned 2. Long practice with feedback: experience includes clear, quick feedback on outcomes

A chess grandmaster—yes. A clinical psychologist with many years of practice—yes. A manager making strategic decisions once every 5 years—questionable.

People tolerate uncertainty differently. Low tolerance for uncertainty → tendency toward premature decisions (closure), avoidance of complex problems, overconfidence (filling the void with certainty).

Expected Value vs Expected Utility: mathematical expectation vs psychological value considering risk aversion. For major stakes—utility matters more than EV.

Pre-mortem: "Imagine that a year from now the project has failed. Why?" Reduces excessive optimism, allows for risk identification in advance.

Reversibility test: Is the decision reversible? If yes—decide faster and learn. If not—invest in analysis.

Irving Janis described groupthink using examples of catastrophic decisions (Bay of Pigs, Chernobyl): highly cohesive groups under pressure make irrational decisions, sacrificing critical thinking for the sake of consensus.

Risk factors: high cohesiveness, authoritarian leader, isolation from external opinions, high stress.

We continue to invest in a failing project—because of resources already sunk (sunk cost), public commitments (hard to admit a mistake), or the need to save face.

Classic examples: policy escalation in the Vietnam War, corporate mergers that proceeded against all signals. In business—projects that "cannot be stopped because too much has already been spent."

Unstructured decisions reproduce cognitive biases. Structure does not guarantee the correct answer, but it reduces the influence of biases and makes the process verifiable and teachable.

W — Widen your options: don't get stuck in the dichotomy of “to do or not to do”. What other options exist?

R — Reality-test your assumptions: what assumptions underlie the decision? How can they be tested?

A — Attain distance before deciding: create emotional distance. “What would I advise a friend?”

Robert Cialdini spent years studying the techniques of persuasion professionals—salespeople, fundraisers, recruiters. His conclusion: influence works through psychological “triggers” that launch automatic compliance.

1. Reciprocity: we feel obligated to reciprocate gifts, concessions, and assistance. Even a small, unexpected gift creates a sense of indebtedness. In negotiations: make the first concession—receive a concession in return.

2. Commitment & Consistency: once we take a position, we tend to stick to it. “Foot in the door”: first ask for something small, then something bigger. Public commitment is stronger than private.

3. Social Proof: in uncertainty, we look at the behavior of others. “92% of customers choose this option”—a powerful trigger.

Definitions

BATNA

— the best thing you can do if negotiations fail. This is your negotiation power.

Roger Fisher and William Ury formulated principled negotiation: focus on interests, not positions; search for mutually beneficial solutions; objective criteria.

BATNA — the best thing you can do if negotiations fail. This is your negotiation power.

Rule: never enter negotiations without knowing your BATNA. Improving your BATNA before negotiations is part of the preparation.

It is important to know not only your own BATNA, but also the assumed BATNA of your opponent. The weaker his BATNA — the stronger your position.

For a long time, negotiation theories ignored emotions, assuming rational actors. Today, research shows: emotions are fundamentally important and predictably influence the outcome.

Anger: in certain situations, strengthens a position (signals firmness). But often leads to unproductive confrontation, destroys relationships, and causes mistakes. Strategic anger (fake anger) is effective but risky.

Happiness and enthusiasm: increase trust and cooperation, but reduce firmness of position.

Emotional preparation: before negotiations, consider your triggers. What makes you angry, offended, fearful—in these specific negotiations?

Manipulation is the use of psychological mechanisms to obtain consent that a person would not give if they had full information and clear thinking. The difference from ethical persuasion: manipulation hides information, creates false obligations, or exploits weaknesses.

Bogey (illusory value): "Condition X is very important to us" (though X is almost unimportant)—so that later they can "concede" it in exchange for something truly important.

Nibbling: after reaching a principal agreement: "By the way, please include this as well..."—counting on the reluctance to reopen negotiations.

Good cop/Bad cop: one is aggressive, the other "defends." This creates artificial sympathy for the "good" one.

Solomon Asch demonstrated: when the majority gives an obviously incorrect answer, a third of subjects agree with the majority against their own perception. Just one "ally" among the confederates who gives the correct answer sharply reduced conformity.

Stanley Milgram showed: 65% of ordinary people are willing to administer "painful shocks" to strangers at the command of an authoritative experimenter, even when the victim screams.

Not villainy, but situational pressure. In organizations: employees carry out ethically questionable orders ("I was told", "that’s the policy", "it’s not my decision").

Descriptive norms: what the majority does. "Most people sort their trash" → people begin to sort.

Forming: group members are polite, cautious, orienting themselves to the situation. There are few conflicts—there is no trust for open discussions. The leader must provide structure.

Storming: differences in approaches, goals, and values come to the surface. There may be struggle for influence. Many teams get stuck here or prematurely revert to conformity.

Adjourning: completion—it's important to properly conclude the shared experience.

Raymond Belbin identified 9 team roles necessary for the full functioning of a team: Plant (Thinker), Resource Investigator, Co-ordinator, Shaper, Monitor Evaluator, Teamworker, Implementer, Completer Finisher, Specialist.

Henri Tajfel demonstrated: people need only the slightest excuse to divide into groups—after which they favor their “own” and discriminate against “outsiders.” Dividing into “red” and “blue” teams already creates in-group bias.

In-group bias: we overestimate the achievements of our own group and underestimate the achievements of others. “We” are good and diverse. “They” are bad and homogeneous.

Contact hypothesis (Allport): direct contact between groups under certain conditions reduces prejudices: equal status, common goals, cooperation, support from institutions.

Superordinate goals: a shared threat or challenge requiring joint efforts drastically reduces intergroup hostility. Sherif’s classic experiment: rival camp groups united in the face of a common problem.

External motivation: an action is performed for external rewards or to avoid punishment: money, recognition, fines.

Internal motivation: an action is performed for the action itself: interest, pleasure, meaning.

Crowding out effect: excessive external rewards suppress internal motivation. Classic experiment: children who drew for pleasure lost interest once rewards were introduced and then removed.

An environment supporting these three needs → high internal motivation, engagement, well-being.

Transactional leadership is based on exchange: good work → reward; violation → sanction. It works to maintain standards, but does not inspire exceeding them.

Transformational leadership influences values, identity, and meaning: "We are doing something important." Four components (Bass): charismatic influence, motivation by inspiration, intellectual stimulation, individual attention.

Identification: people share the leader's values and identify themselves with the group. "We are a company that is changing the world" creates stronger motivation than a bonuses scheme.

Vision: a clear, persuasive picture of the desired future creates direction and meaning. Without vision—management of details; with vision—movement toward a goal.

The efficient market hypothesis (Eugene Fama) claims: asset prices reflect all available information. Consequence: it is impossible to systematically "beat" the market.

Behavioral finance (Kahneman, Shiller, Thaler) demonstrate: markets can be systematically inefficient, because investors are people with cognitive biases.

Momentum: stocks that have risen during the past 12 months continue to rise (and vice versa). This contradicts the random walk hypothesis.

Value premium: stocks with low P/E, P/B systematically outperform "expensive" stocks in the long run.

Warren Buffett: “Be fearful when others are greedy, and greedy when others are fearful.” This is not just an aphorism—it’s a behavioral observation about systematic errors made by the mass investor.

Optimism → Enthusiasm → Euphoria (price peak) → Anxiety → Denial → Panic → Capitulation → Depression → Hope (price bottom) → Relief → Optimism

Most retail investors buy near the peak and sell near the bottom—exactly the opposite of the optimal approach.

Disposition effect: selling rising positions too early (locking in gains) and holding losing positions for too long (avoiding realizing losses). Result: systematically lower returns.

Robert Shiller described five characteristics of market bubbles: 1. Sharp price increase 2. Narratives explaining “why this time is different” 3. Media frenzy 4. Stories of rapid enrichment 5. Growing participation of retail investors

Tulip mania (1637): prices for tulip bulbs reached the value of a house. When the bubble burst — the market collapsed within a few weeks.

Dot-com (1997-2000): companies with no revenue were worth billions. Narrative: “The internet changes everything, old valuation metrics no longer apply.”

Subprime (2003-2007): “Home prices never fall on a national level” — a narrative that turned out to be false.

Behavioral finance not only describes problems, but also provides opportunities for a disciplined investor. If the market systematically makes mistakes, you can systematically take advantage of this.

Value investing (Graham, Buffett): buy assets trading below their intrinsic value due to pessimism, fear, or neglect. The market overreacts to bad news → shares of “hated” companies become cheaper than justified.

Contrarian investing: buy what is currently out of favor. “Everyone is buying gold” → gold becomes overvalued. Requires psychological strength to go against the crowd.

Momentum (trend following): in the short term, trends continue due to underreaction to news and herding. Momentum strategies work on a 3–12 month horizon.

Neuroeconomics—at the intersection of neuroscience, psychology, and economics—studies the neural mechanisms of economic decision-making. What happens in the brain when we win, lose, take risks, or trust?

The dopamine system responds not so much to the reward itself as to its anticipation and unpredictability. Unexpected rewards (as in a casino) stimulate dopamine more strongly than predictable ones.

Implication: Financial markets, with their unpredictability, activate the dopamine system like a slot machine. Frequently checking your portfolio creates dependence and increases impulsivity.

fMRI studies: losses activate the insula (associated with pain and disgust) more strongly than gains activate pleasure centers. Loss aversion is literally “painful” on a neural level.