Herding Behavior: How following the crowd leads us astray

 

“Thus it might be that one family camped near a spring, and another camped for the spring and for company, and a third because two families had pioneered the place and found it good. And when the sun went down, perhaps twenty families and twenty cars were there.”

This quote from John Steinbeck’s classic the Grapes of Wrath paints a powerful reality about human nature. It depicts humans as the social animals that we are.

In times of uncertainty, people are afraid, and when we’re afraid, we rely upon the herd to guide us.

Sure, the crowd’s guidance can be a useful crutch to lean upon, but what happens when we use it too often–when we’re just lazy?

The concept we’re teasing out here is known as: herding behavior and we can define it as: people doing what others do, instead of using their own information to make decisions.

This happens often. We see a large number of people acting in the same way, and we think “there’s no way that they could all be wrong. They must know something that we don’t.”

We start to base our decisions off of the assumption that everyone else has done their research or knows something that we don’t. But, that’s not always the case.

Consider the following example offered by Robert Shiller, an economist at Yale:

Suppose two restaurants open next door to each other–Restaurant A and Restaurant B.

Every new customer must choose between the two.

The very first customer sees two empty restaurants and must choose which one to eat at based only on their appearance. Let’s say she chooses restaurant A.

The second customer sees one person eating at restaurant A and an empty restaurant B. She makes her choice based on two things:

  1. The appearance of each restaurant (her own information) and
  2. The fact that the first customer chose restaurant A (information from others)

If the second customer chooses to go to Restaurant A, the third customer will see two people eating at Restaurant A.

I think you see where this is going.

As people continue to join the crowd, they prompt others to do the same. Eventually, all customers may end up at Restaurant A, which could actually be the poorer restaurant.

What’s happened is: People have ignored their own information and that creates a distorted signal chain. We think that everyone has made an informed decision, and that decision appears to have value. But in reality, everyone has based their decisions on the decisions made by others, and because of this, our decisions contain no real valuable information.

These chains of behavior are sometimes called informational cascades, and they help us explain everything from standard conformity to fads and booms and crashes.

Speaking of booms and crashes. You might remember the financial crisis of 2008. While an event as cataclysmic and complex as that cannot be explained with one behavioral failure, research suggests that herding behavior may have played a role in decision making by investment managers.

Investors concerned with their reputation have been shown to mimic the investment decisions of other managers, ignoring their own private information.

It’s worth returning to the idea that, In times of uncertainty, people are afraid, and when we’re afraid, we rely upon the herd to guide us.

As the financial world collapsed in 2008 and uncertainty loomed above us all, there’s no question that our herd mentality must have played a role in our decision making.

Whether or not we’re aware of it, our reliance upon the herd plants the seeds which will influence the stores we shop at, the restaurants we try out, and even the universities we choose to attend.

The solution is not to avoid all external information. Rather, the idea is to become more aware of the information we’re using to make decisions, especially when we’re observing what other people are doing.

The herd is not synonymous with bad; however, our over reliance upon the herd prompts ignorance and distorts the information we use to make decisions.  

 

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The Lens of Rationality: Why Bounded Rationality Matters

note: This post is the script for a short video I just released. The video can be found on at the end of this post and on the Intermittent Diversion YouTube channel.


 

Alright, let’s imagine I’m trying to catch a fly ball–how do I decide how to best position myself to catch that ball?

The obvious answer is to calculate the ball’s arc and trajectory using this formula and then find the exact place I should stand to catch the ball

And I’m going to do this because I’m rational…right?

Probably not.

I might be rational, but there’s no way I could calculate the ball’s trajectory and find the best place to position myself before it lands.

The point that I’m teasing out here is that we humans have what’s called “bounded rationality.”

And this just means that, when we make decisions, we have limits. We only have access to so much brain power and knowledge and we only have so much time to make a decision.

As a result, we’re going to rely upon our intuition and we ’re going to use mental shortcuts to make quick decisions.

This is why–when that fly ball is coming towards me, I’m going to keep my eye on it and stay under the ball–I’m going to use my intuition to figure out how to catch the ball, I’m not going to calculate its path.

Now, bounded rationality says that there are limits on our rationality, but it doesn’t mean that we are irrational. It’s more of an acknowledgement that we are part rational and part irrational in our actions.

We don’t operate in binary–we operate on more of a spectrum. Where we sit on this spectrum changes based on our environment and the resources available to us.

Rational decision making models are great–they give us useful ways of looking at the world, but they often fall short in the sense that humans don’t actually use them.

Reality isn’t characterized by simple environments and limitless resources.

This is why we use mental shortcuts instead–they help us navigate complex environments.

This is important because: how we understand rationality influences the way we look at the world. And to create a more realistic view of the world, we need to remember that:

  1. Our environment is complex and our resources are limited
  2. We are part rational and part irrational in our actions

When we view the world through the lens of rationality, we set ourselves up for failure. We expect too much of ourselves, we make poor predictions, and we’re left unhappy.

But, we don’t have to do this. Once we recognize the limits of our rationality, we can start to understand how we deal with the world we live in. We can paint a more realistic picture of human beings. We can accept our nature and work with it rather than against it.

“Human behavior is intendedly rational, but only limitedly so”

–Herbert Simon

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How the Brazilian government used psychology to market a new currency

What is a government to do when rampant inflation cripples a currency and the public’s faith in it’s ability to hold value?

Brazilian policymakers faced this very question nearly thirty years ago. In a bold move, they chose to answer this question by creating and marketing a new currency–the Unit of Real Value–which existed in name only. No coins or bills of the Unit of Real Value would be issued. This is the story of Brazilian hyperinflation, and at its epicenter is a story about changing a culture using basic psychology principles.

After the energy crisis of the 70s, Brazil experienced a decade and a half long battle with hyper-inflation.

Prices rose so rapidly that stores were forced to change sticker prices multiple times a day. As the prices of goods like milk and eggs skyrocketed, the ten dollars you had today was only worth a fraction of that come next week.

As Brazilians experienced price increases day after day, they began to expect further price increases–a self fulfilling prophecy which shattered public confidence and furthered the economy’s downward spiral.

Brazil found itself in constant flux, with new administrations taking their own shots at hyperinflation. They tried freezing prices, slashing zeros, and they even changed their currency five times in one decade. Nothing seemed to solve Brazil’s hyper-inflationary woes.

The program which would ultimately pull Brazil out of the gutter was the Real Plan.

It was drafted by a group of Brazilian economists and it sought to do two main things:

1. Slow down the creation of money
2. Restore the people’s faith in Brazilian currency.

The importance of the first task–slowing down the creation of money–cannot be ignored, and much of the plan’s success is owed to the monetary and exchange rate policies that targeted the root causes of the crisis. That being said, we’re going to focus on the second task–restoring the public’s faith.

Once 1993 hit, the Brazilian Cruzeiro was no longer a viable way to store value—whatever cash you had lost value by the hour. As a result, Brazil experienced a bizarre culture which favored the here and now over the future–any planning for the future was foolish as time sucked the value out of your money.

Officials needed to break this inflationary mindset of Brazilians and convince them that Brazilian currency was stable.

To do this, they created a ‘virtual’ currency called a Unit of Real Value—a URV. It was virtual in the sense that it did not exist in bills or coins. The sole purpose of this currency was to act as a unit of account. You would go to the store and prices would be listed in URVs, but you would still pay in Cruzeiro. URVs remained stable in the midst of hyperinflation. This provided Brazilians with a stable anchoring point for purchasing goods. URVs didn’t fluctuate much, but Cruzeiros were still devaluing rapidly.

You would go to the store and buy Milk for 1 URV. 1 URV might equal 10 Cruzeiros. When you went back to the store next week, Milk would still be 1 URV. But now, 1 URV might equal 20 Cruzeiros.

Nobody really understood what a URV was, but it was simple to use, and over time it became easier to just think in terms of URV and then do the Cruzeiro conversion at the counter.

The purpose of the URV was to provide people with a stable anchor point and gradually get them to expect those prices to remain constant. After only a few months of the URV system, officials felt that the public no longer feared future price increases and they introduced the Brazilian Real. The Real would replace the Cruzeiro and its value would be equal to one URV. All wages and prices in Brazil would now be listed and paid in Real.

The Brazilian government had essentially created a new currency and marketed it in a way that communicated stability and credibility to the Brazilian people.

They did so using an anchoring mechanism to reprogram the minds of Brazilians, getting them to believe that currency could hold its value.

More importantly, a people regained control over their lives. In a BBC article, Clemens Nunes explains, “Brazilians suddenly became capable of making plans for the future, instead of having to live in the here and now”

When you read about the URV maneuver, many people describe it as if the Brazilian government ‘tricked’ their people into thinking their money would hold its value. On some level this is true; however, the real plan was characterized by transparency. There were no surprises or shocks–officials simply took a bet on their understanding of their people’s psychology…and it worked.

Kahneman and Tversky: Judgment under Uncertainty

A classic paper from Daniel Kahneman and Amos Tversky examines the role that heuristics play in our decisions, predictions, and assessments in situations characterized by uncertainty.

This video attempts to illustrate the ideas presented by Kahneman and Tversky in their 1974 paper, Judgment under Uncertainty, which was originally published in Science. The paper looks at three heuristics which are commonly employed: representativeness, availability, and anchoring.

The original paper can be found here: https://www.jstor.org/stable/1738360?

The IKEA Effect: Why everyone around you is photographing the same scene

One of my favorite shrines I had the chance to visit in Japan was the Fushimi Inari shrine in Kyoto. The shrine grounds are uniquely picturesque—the winding pathways are scattered with miniature shrines and lined with thousands of orange torii gates. I had a hard time resisting the urge to take photos as we strolled through the mountainside.

As a result, I took roughly fifty iPhone photos of Fushimi Inari, all of which can be found in my personal photo library. But these fifty photos pale in comparison to the thousands of professional photos that are readily available with a quick google image search of “kyoto fushimi inari.” I was completely aware of the plethora of photos available on google as I made my way through the shrine, yet I chose to take my own iPhone photos.

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Beyond this, nearly every one of my friends chose to take their own photos of the exact same scene. This happens everywhere—concerts, sporting events, gorgeous landscapes—you name it. With the advent of cell phones and personal cameras, it has become commonplace to see a handful of people photographing identical scenes.

There are two main reasons why someone might take a photo: (1) to share the moment, or (2) to remember the moment. A professional photo is often adequately suited, if not preferred for either purpose. With this in mind, artists like Jack White have hired professional photographers for their shows, providing concert-goers with free, high-quality photos and allowing people to devote their undivided attention to the present moment. But people still attempt to take their own photos…why?

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The IKEA Effect

A possible explanation lies in what researchers have termed the IKEA effect. At it’s core, the IKEA effect posits the idea that labor leads to love. Researchers have found that consumers tend to assign a higher value to products they have self-assembled than to pre-assembled products of similar quality. In our minds, the addition of our own labor increases the value of a product.

You might value the coffee table you assembled from IKEA more than the one your friend bought pre-assembled at Target, though they are in large part identical. Yours might even be more likely to fall apart in a few months.

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This example deals with the furniture in your house, but the same could be said for the photos in your camera roll.

You might like the concert photo you took with your iPhone last weekend more than the one another concertgoer took with professional equipment, though they both capture the same thing. Your photo might even be a bit blurrier and hard to make out. Still, you will most certainly show your own photo to your friends—you might even make a print of it to hang on your wall.

The Balance of Time

As technology improves our ability to take a quality photo with little technical knowledge, it reduces the need for professional equipment and skill. Anyone with a phone can and will do it—the amount of labor required is minimal, and the increase in (personal) valuation is significant.

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Unfortunately, such a system incentivizes us to lose sight of the present moment and its inherent beauty. We do not want to forget what we want to remember. As a result, our efforts are aimed at preserving the option to remember the present moment at a later date—an action which prompts us to discount the present moment in favor of the future.

There must be a way to preserve the sanctity of the present moment while keeping this option for future remembrance open. I believe the answer to this dilemma lies somewhere in our ability to overcome the IKEA effect—the mechanism which prompts our increased valuation for similar goods, merely because we took the photo.

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Extraction Part VI: Conclusion—Metaphors

Making coffee is a relatively simple process; coffee’s flavor compounds are extracted using water as a solvent. But, we can affect the extraction rate of a coffee through five variables: temperature, agitation, time, ratio, and grind size. This is the final post in a series examining the factors affecting extraction in coffee and what they can teach us about the daily pursuits we engage in.

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Over the past few weeks, we’ve taken a look at the five variables affecting coffee extraction: temperature, brew ratios, agitation, time, and grind size. The manipulation of these variables allows us to control the brewing process.

Parallels between these variables and the variables that impact our everyday lives can easily be drawn:Scannable Document on Jul 3, 2017, 10_31_50 PM

Connections

While the exact comparison may differ from person to person, the point is this: there are variables in our lives that we have control over, and the interaction of those variables determines the end result of our work.

Focus may be hard to conceptualize. Balance may seem difficult in practice. Curiosity may seem arbitrary or random. Whether or not these specific variables resonate with every individual is not important.

What’s important is the process of thinking about the variables we can control in our lives and how they interact with each other. Think of a set of intensity sliders that allow us to increase or decrease each variable.Scannable Document on Jul 3, 2017, 10_26_37 PMToo much or too little intensity can produce undesirable results; brewing at the extremes can lead to over-extraction or under-extraction. Working to find the optimal balance will leave us better than before.

Metaphors

Metaphors provide tremendous insight into our lives, and they’re beautiful because they bend. A metaphor is not an exact definition; it’s a pliable framework.

Finding metaphors that allow us to improve our understanding of ourselves and the world around us helps us lead better lives. Coffee extraction is one that resonates with me, but it certainly does not have to resonate with you.

There is no “one” perfect brew recipe, there is no “one” perfect metaphor for life, and there is certainly no “one” way to live a fulfilling life. Which metaphors work for you?

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Baye’s Theorem and Intuition

Last week, we discussed Bayes’s Theorem briefly. We used a simple example of walking into a classroom and observe three people wearing different shirts.

This week, we are going to utilize this same example, but we will examine the mechanics of what’s happening through the lens of Bayes’s Theorem.

To do this, we will take a quick look at Bayes’s Theorem and then use its predictive insights to shed some light on our previous example and provide additional understanding of our own intuition.

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