Decisions under uncertainty

risk_uncertainty

We make decisions every day.

For the sake of argument, let’s break them down into a few categories.

There are decisions where:

  1. Outcomes are known. This is the easiest way to make decisions. If I hold out my hand and drop a ball, it will fall to the ground.
  2. Outcomes are unknown, but probabilities are known. This is risk. Think of this as going to Vegas and gambling. Before you set foot at the table, all of the outcomes are known as are the probabilities of each. No outcome surprises an objective third party.
  3. Outcomes are unknown and probabilities are unknown. This is uncertainty.

We often think we’re making decisions in #2 but we’re really in #3.

Ignorance is a state of the world where some possible outcomes are unknown: when we’ve moved from #2 to #3.

One way to realize how ignorant we are is to look back, read some old newspapers, and see how often the world did something that wasn’t even imagined.

Some examples include the Arab Spring, the collapse of the Soviet Union, the financial meltdown.

We’re prepared for a world much like #2 — the world of risk, with known outcomes and probability that can be estimated, yet we live in a world with a closer resemblance to #3.

Read part two of this series: Two types of ignorance.

References: Ignorance: Lessons from the Laboratory of Literature (Joy and Zeckhauser).