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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