Decisions Under Uncertainty

"We confuse risk and uncertainty."
“We confuse risk and uncertainty.”

If you're a knowledge worker you make decisions everyday. In fact, whether you realize it or not, decisions are your job.

Decisions are how you make a living. Of course not every decision is easy. Decisions tend to fall into different categories.  The way we approach the actual decision should vary based on category.

Here are a few basic categories that decisions fall into.

There are decisions where:

  1. Outcomes are known. In this case the range of outcomes is known and the individual outcome is also 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. I know this with near certainly.
  2. Outcomes are unknown, but probabilities are known.In this case the range of outcomes are known but the individual outcome is unknown. 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. In this case the distribution of outcomes are unknown and the individual outcomes are necessarily unknown. This is uncertainty.

We often think we're making decisions in #2 but we're really operating in #3. The difference may seem trivial but it makes a world of difference.

Decisions Under Uncertainty

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).