WHY WEDISAGREE

Structured problem solving &

Should you do X?

What was the flaw in my logic?

The more frequent mistake

How much is it worth?

Expected Value (EV)

𝐸𝑉 (𝑋)=∑𝑖=1

∞

𝑥 𝑖𝑝𝑖

the sum of ( the products of ( each outcome’s value probability))

Expected Value (EV)

Let’s play a game

Flip a coin

• Heads: you win $1000• Tails: you lose $1000

EV(playing game) =

Expected Value (EV)V = value

P = probability

EV(playing game) =

Expected Value (EV)V = value

P = probability

EV(playing game) =

EV(playing game) =

Expected Value (EV)V = value

P = probability

EV(playing game) = EV(playing game) =

Back to the warranty

EV(warranty) =

Expected Value (EV)V = value of warranty

P = probability

EV(warranty) =

Expected Value (EV)V = value of warranty

P = probability

EV(warranty) =

EV(warranty) =

Expected Value (EV)V = value of warranty

P = probability

EV(warranty) =

How do you figure out the probabilities?

$59.99 / $547.99 = 10.9%

The best tool for estimating probabilities isHistorical Data

EV(warranty) =

Expected Value (EV)V = value of warranty

P = probability

EV(warranty) = EV(warranty) =

All figured out?

All figured out?not quite

Flip a coin

• Heads: you win $1000• Tails: you lose $1000

It’s not irrational, Utility()

securely having $1000 is better than50% having $2000 + 50% having $0

For most people

In terms of Utility

Utility($1000)is greater than50%Utility($2000) + 50%Utility($0)

For most people

Imagine $1000 is all you have

Utility(first $1000) > Utility(second $1000)

Utility(not playing the game)is greater thanUtility(playing the game)

For most people

…But not everybody is the same way

For most people

Flip a coin

• Heads: you win $100,000• Tails: you lose $1000

Flip a coin

• Heads: you win $?• Tails: you lose $1000

Flip a coin

• Heads: you win $?• Tails: you lose $1000

take 10 seconds

People value the same things differently

People have different Utility Functions

Practical use in terms of projects?

Different resources

U(implement feature) = U(value added by feature) + U(time cost)

U(implement feature) = U(value added by feature) + ??% U(-1 day) + ??% U(-1 week) + ??% U(-2 weeks)

Should you do X?

Find the Utility of doing X byFiguring out the probabilities and payoffs of all benefits and costs

Should you do X?

Find the Utility of doing X byEstimating to the best of your ability the probabilities and payoffs of as many benefits and costs as you can think of

Should you do X?

Compare Utility(do X) with Utility(do Y)

Should you do X or Y?

Why we disagree

Incomplete information

Solution:

Exchange information

Differing utility functions

Solution:

Explain and extract motivations

Solution:

Explain and extract motivationsTry to avoid guessing

Differing estimates

Solution:

Historical data?

Solution:

Historical data?You might be stuck

Sources and related material• Getting to Yes

by Fisher, Ury and Patton

• Difficult Conversations: How to Discuss What Matters Mostby Stone, Patton and Heen

Other practically useful / interesting econ-related concepts• “Lemons” and information asymmetry • The “cobra effect” and perverse incentives• Opportunity Cost• Marginal utility