Decision-Making Under Uncertainty

The board behind every bet you don’t realise you’re making: what a perfect calculator would pay for a choice, and what you actually feel about it.

Before you start. Cognitive Biases named loss aversion and framing as two of the mind’s shortcuts. This lesson turns those into the full arithmetic of a choice made under uncertainty, and ends on the one calculation almost everyone gets wrong. You only need to be able to multiply two numbers and add the results.

The idea in 30 seconds

A decision with an unknown outcome is a bet. Multiply what could happen by how likely it is and add it up; that total is called expected value, the calculator’s answer.
People routinely turn down a bet with a better expected value, because losing something you have hurts roughly twice as much as gaining the same amount feels good. That sting is loss aversion.
Prospect theory is the measured model of how people actually feel a bet: losses weigh more than equal gains, and rare odds feel bigger than they are while near-sure odds feel smaller.
Stretching a rare chance and shrinking a near-sure one is why the same person buys a lottery ticket and an insurance policy in the same afternoon.
A test can be right 99% of the time and still be wrong most of the time it flags you, if what it’s testing for is rare. The rate of the thing itself is the base rate, and leaving it out is the most common way this goes wrong.

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