Re-Thinking Fast and Slow

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Abstract

Daniel Kahneman’s book Thinking, Fast and Slow (2011) has had a worldwide impact. The book’s insights are profound and have changed the thinking of both decision scientists and general audiences about how choices are made. Kahneman, however, claims that standard utility theory cannot explain these insights because it 1) lacks “reference points” from which gains and losses can be measured, 2) does not predict loss aversion, and 3) assumes preferences are stable (amid supposed counter evidence). These alleged failures of utility theory are what led Kahneman and Tversky (1979, 1991) to develop prospect theory. This brief article shows that a close reading of Thinking, Fast and Slow reveals fundamental oversights in these criticisms. Not only does loss aversion arise naturally within utility theory for rational economic agents with stable preferences, but the very measurements of gains and losses rely directly upon reference points.  Rather than overturning the insights of prospect theory, proper use of utility theory and its indifference curve representations reveals these behavioral insights and places them within the sturdier, longer-established framework of neoclassical microeconomic theory.

Posted for comments on 14 Oct 2020, 2:08 pm.

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