[MUSIC]
>> [APPLAUSE]
>> Thanks very much.
And welcome back to the farm.
Like was mentioned,
this is a hard place to leave.
[LAUGH] So much so
that some of us never get escape
velocity to actually go very far.
And I'm looking forward actually,
next year is my 25.
So I'm looking forward to coming back,
although I'll already be here.
So what I wanted to do was spend a little
bit of time taking about probability and
decision making.
And sort of as we go along, I may ask for
some interactivity on your part as well.
So, as you know,
decision making is not a spectator sport.
And so along the way they'll probably
be some decisions we need to make.
One of the things, I have a very
high level of respect for alumni.
So I will try not to pelt you
with candy unless you want to be.
The students I have actually like
it when I throw it out to them.
>> [LAUGH]
>> But I figure in this,
you're a well known crowd,
I probably shouldn't [LAUGH]
necessarily be throwing things,
but just so you know.
What I wanna spend a little bit of time
doing just to start is to kinda frame
the problem.
And then we need to talk
a little bit about some notation,
get into a little bit of math.
And then talk about what that
really means when we start
thinking about decision making.
So a lot of the decisions we
make involve uncertainty.
In some sense they have to involve
uncertainty because if they don't involve
uncertainty and
we don't have multiple choices to make,
we really don't have a decision at all.
So, the times when we think
about having a decision to make,
it's because we have options
from which to choose.
And we have some uncertainties surrounding
what might be the outcomes with respect
to those options.
And so, part of the idea is,
could we actually use that fact?
When we think about that uncertainty could
we quantify it in a way that will allow us
to make better decisions?
And so probability's gonna be the
mathematical tool that's gonna underlay
what we do.
The basic idea is that it's just a way
to formally quantify uncertainty.
If we don't know when
something's gonna happen,
we wanna be able to put some chance or
some probability on that.
And that gives us a way to be able
to reason more formally about it.
And so when we think about the future and
there's uncertainty in the future,
this is gonna be the notation we use
to think about that uncertainty.
And if we can quantify it then
maybe we can make better decisions.
And so some of you may know the decision
analysis is a field that existed for
a long time.
The term decision analysis was actually
coined by our own Ron Howard here over 50
years ago.
And basically, it's a normative
process for decision making.
So, what I mean by that, its the way
decisions for some definition of should,
should be made.
It's not necessarily how
they actually are made.
And we'll talk about that.
People make irrational decision for some
definition of irrationality all the time.
But this notion of the kind of
decision we should be making and
the principle that underlies it is
a notion of maximizing expected utility.
To understand that notion,
we need to understand what utility is,
what expectation is, and
then how to maximize it, and so
we'll talk about all those things.
But one thing to also keep in mind is
not all decisions are appropriate for
formal analysis.
That's something that Ron
always liked to say too.
The decision of who to marry is not
necessarily one that you do formal
analysis on.
I don't know.
Is he gonna lose his
hair 20 years from now,
let me write down a probability for that.
Not something we think about right?
So there are some decisions for
which this is not suited for.
But there are many sort of, we could think
of as rational decision making places were
this framework could work.
So, let's talk a little bit about some of
the underlying math to kinda get started.
And by the way, I should mention,
if there's any questions or
anything's unclear along the way just feel
free to ask a question, yell it out or
raise your hand.
It's much easier to make sure that
everything's clearer as we go along rather
than waiting until the end for questions.
So, first thing,
if we wanna be mathematical, one thing
mathematicians always like to do,
is they like to give highfalutin
names to really simple concepts.
So it looks like what we do is more
complicated than it really is.
Okay, so
the first thing we're gonna do, and
by the way I brought my trusty lightsaber.
Cuz I grew up in the Star Wars generation.
And I just think it makes for
a nicer pointer.
So that's really all it is [SOUND] but
it does turn on.
>> [LAUGH]
>> So if anyone gets outta line,
[LAUGH] I got the light saber.
So a sample space is the first
concept we talk about.
And a sample space is just a term for
a very simple idea.
It's the set of all possible
outcomes of an experiment.
What does that mean,
what is an experiment, what are outcomes?
So if I take this thing,
it's my big six-sided die and
I roll it, that's an experiment.
I don't need a white lab coat.
I don't need an Erlenmeyer flask.
All an experiment is is something for
which until I do it,
I don't know what the result is.
So when I roll this die, until I roll
the die, I don't know what the outcome is.
But there's a set of possible
outcomes that could happen.
The set of all possible outcomes
that could happen is what's known as
the sample space.
So if I flip a coin,
I also brought my giant coins with me.
If I flip a coin, there's two
possible outcomes, heads and tails.
So that becomes the sample space is
the set of all possible outcomes.
If you're one of the old
Twilight Zone fans and you're like,
what if it lands on it's side and
then I can read minds.
That never happens, okay?
So we just have heads and tails.
If I flip two coins, I can think of
the silver coin and the gold coin.
Not real silver and not real gold.
But, these are separate coins.
So if I flip both of them,
I can think about four possible outcomes.
Namely, I get heads and heads.
I get heads and tails.
I get tails and tails.
Or, I get heads and
tails in the other direction.
So it matters which coin for
example the outcome happens on.
And we just refer to those as pairs,
so we have these four pairs up there.
Rolling a six-sided die
has six possible outcomes.
If I roll two dice and I ask for
the sum of the two dice,
then the possible values that can
come up are the numbers 2 through 12.
So the other concept we need to
think about is something known
as an event space.
An event space, again, is a simple concept
with sort of a highfalutin definition.
The formal definition is it's
the sum subset of the sample space.
What does that actually mean?
What that means is,
of the outcomes that are possible,
what are the ones we care about?
So if I flip a coin and I say,
care about the coin coming up heads.
Then the event space is heads, which
is a subset of all possible outcomes,
heads and tails.
If I flip two coins, and I say I care
about getting at least one head.
Then I consider all the possibilities
where there is at least one head.
Namely, I could get two heads,
I could get a head and
a tail with the heads on the gold die.
Or on the gold coin.
Or I could get a tail on a head where
the tail is on the gold coin and
the head is on the silver coin.
But tails tails is not a possibility
that satisfies the event I care about.
If I care about rolling an odd number,
it's the numbers one, three, and five.
If I care about rolling
a number greater than 8,
it's just 8 through 12 on the two dice.
So that's our event space.
And so when we think about that,
there's a set of things that could happen,
there is some set that we care about.
Then it becomes a question of determining
how likely are the things we care about.
And so some things have what
are known equally likely outcomes.
So if I role a die,
if I assume this die is fair,
then all possible sides one
through six are equally likely.
And that happens a lot in the real world.
So with flipping a single coin,
with flipping two coins, assuming
the coins are fair, rolling a six-sided
die, all the outcomes are equally likely.
And so the probability,
which is the notation I'm gonna use here,
p of a given outcome,
is just 1 over the number of outcomes.
So if I roll this die,
the chance of rolling a five is one sixth,
cuz there's six possibilities.
The chance of rolling an odd
number is three over six cuz
there's three possible odd
numbers out of six possibilities.
And so that generalizes.
In the case where there's some
event e that we care about,
like rolling an odd value,
we just look at the number of
outcomes that satisfy the event
we care about divided by
the total number of outcomes through the
size of the samples basis we say about it.
And so that defines in a special case
where it with equally likely outcomes
the chance of different things happening.
So as I mentioned, flipping heads has
a 1/2 chance of happening, rolling a 5 or
6 is 2 out of 6 possibilities, or 1/3.
Now, where this begins to get interesting
is we can begin to look at some examples
where things become counter-intuitive.
So I'm gonna give you some classic
statistical problems that sometimes
people bring up.
But if you've seen these before don't
yell out the answer, if you haven't,
we'll go through them.
So one of the classic ones is birthdays.
What's the probability that if I have n
people in a room, so you are n people for
some number n, which is probably
I'd say around 100, maybe 150.
What's the probability that none
of you share the same birthday?
Now that's regardless of year, so
that's our first caveat, so it's actual,
just calendar day.
And we're going to rule out leap years.
So just wondering,
anyone born on February 29th?
No one, shocking.
Because I have a son who was almost born
on February 29th, and the doctor told us,
if he's really born on February 29th,
you can either pick February 28th or
March 1st as his birthday.
So it turns out, there's actually
very few people, for many reasons,
there are very few people who
are born on February 29th.
So if we use this little bit of
mathematics that we've seen so far,
how can we figure out
the chance of this happening?
So if the number of ways to
have birthdays for n people,
each of the people can choose any one
of 365 days to be their birthday.
So if we want to say, what are all the
different ways we could set birthdays in
this room, each of the n people
can pick one of 365 days.
And so the number of possible ways to
specify birthdays is 365 to the nth power.
So how many ways can we specify
a birthday such that no two
people share the same date?
Now we create a constraint, because the
first person, if we were to start here,
you get to pick any one of 365 days.
You can pick any one of the days
except for the one he picked, so
that gives you 364 options.
You have 363, 362, etc.
And so
as you can imagine if we had 366 people,
there's no way we wouldn't have one
that wouldn't share a birthday.
But basically what we get is this
little series that each person
has one fewer option, and
we multiply all the options together.
So our probability is basically just
what we refer to as the event space,
the way we can set all the birthdays that
satisfies the condition we care about.
Namely, that no one shares a birthday,
that's the numerator.
The denominator becomes all the ways
we could specify birthdays,
that's our sample space.
And so we get this interesting
little fraction that the bottom and
top both have n terms that we multiply.
The one on the bottom is 365 and
it remains that.
The one on the top just decreases by one
every time we do the multiplication.
When we see something
like that we might say,
how many people that we need to
have before we share a birthday?
So I'm gonna do a little
experiment in here.
I'm gonna start with a month,
everyone whose birthday is in that month,
raise your hand.
And then I will call on you and you
yell out which day of the month is your
birthday, and if there's someone else in
the room that matches, yell out match.
And I'm willing to bet,
in this room we have a lot of people but
we have maybe half the calendar covered,
that we are virtually guaranteed to
have two people share a birthday.
So January, all the Januaries,
hands up, what day?
>> 7.
>> Anyone January 7?
No, all right, next January?
>> 26th.
>> Next January.
>> 30.
>> Third?
No one's a match yet?
>> 12.
>> 12, 18 any other Januaries?
>> 15.
>> 15.
>> 1st.
>> 1st.
>> 8.
>> 8.
Any other Januaries?
We could actually make it a month
without any, way back there.
>> [INAUDIBLE]
>> Which Day?
9th, all right so no Januaries, amazing.
Now let's do February,
all the February hands up.
Date?
[INAUDIBLE]
>> Match.
>> Match, so we finally got a match.
So we got to February, which I'm actually
astounded we even got to February.
And the reason why is if we looking at
these numbers, the chance of there being
two people with a matching birthday,
if we have 23 people in the room.
That's a tiny fraction in the whole
calendar, that's less than one-tenth you
could think of as the size of
the number of days in a calendar.
And at that point, there's a 50%
chance already two people match, okay.
If we go up to 50 people,
it's now less than 3%.
If we go to 61 people,
we get to less than half a percent.
And we get to 80 people,
we're already down to one
one-hundredth of a percent, all right?
So in this room, it was near guaranteed.
With 150 people,
it turns out it's roughly about one over
three times ten to the 17th power, okay?
So I was almost willing to put money on
it, but there's still a non-zero chance.
>> [LAUGH]
>> And I was like okay, there's a small
chance it couldn't, I actually got
worried when we got through January.
So it's somewhat counterintuitive that
this would be the case, but it turns out
if you look at the problem more closely,
it's not that counterintuitive at all.
And the reason is here's the first person,
they pick a birthday.
Here's the next person,
they pick a birthday, and we compare them.
Then when we have the next person,
we compare them to both of the others.
And with the next person we compare
them with three others, and
the next person we compare
them to four others.
And you can see quadratic growth in the
number of comparisons we make as we add
more people.
And so that's why this number drops off so
quickly
in terms of the number of people relative
to the actual size of the calendar.
But if we take this same concept and
tweak it just slightly,
the problem looks very similar, but
the dynamics completely change.
So now let's consider the probability
that we have n people in a room, so
we'll say n people other than me,
what's the probability that someone in
here shares the same birthday as me?
Okay.
So if we wanna think
about that numerically,
we'd again say how many ways can we
assign birthdays to everyone in the room,
365 to the nth power,
because anyone can have any birthday.
How do we assigned birthdays to people in
the room such that no one has the same
birthday as me is 364 to the nth power,
because everyone can pick a day except for
my birthday.
And so the probability that we
would satisfy the condition
that no one has the same birthday as me
is just 364 to the n over 365 to the n.
It look super similar to
what we had before, right?
The denominators are the same, the only
difference is that numerator sort of
remains the same every time we multiply
it, rather than decreasing by one.
That completely changes
the problem dynamic.
So, it turns out now if we have 23 people,
which before gave us a 50% chance of
matching birthdays, in this setup there's
a 93.9% we have no matching birthdays.
At 100 people at 76%,
we still have no matching birthdays.
250 people is what we need to get to
before there's a 50% chance of matching
birthdays, which seems counterintuitive.
Because you ask most people if you had
a calendar, how many people would you need
to have a 50% chance of someone
matching a birthday as you?
They'd probably say, around 183,
about half the calendar.
It turns out that's not the case, because
people can share each other's birthdays.
So here is you, first person comes along,
we compare them to you.
Next person comes along
we compare them to you,
next person comes along
we compare them to you.
The only issue is,
these people can share the same birthday
and there is no issue with that.
So we don't have to get,
we need more than 180 people
to get half because some of those
people actually share birthdays.
So just ask.
So that's why these probabilities are so
much higher than before.
Anyone's birthday May 10th?
We actually got one, come on down.
>> [LAUGH]
>> That's my birthday.
>> [APPLAUSE]
>> I've never had that happen before.
>> [LAUGH]
>> So, if, actually you know what?
I'm gonna give you a candy right now,
you're gonna be a volunteer for
our next experiment that we're gonna do.
Okay, so if you want to just
hold on right in the front row.
That's amazing.
So, the chance of it was,
with this size crowd,
there was actually probably around
50% chance it would happen.
But I've never actually had that before,
but they were smaller crowds.
Okay?
So the next thing we want to think about,
so
now we get a little bit of the notion of
just trying to understand the problem
dynamics we need to pay
a lot of attention to.
The next think we think about
is what information do we
have available at the time
we make a decision, okay?
And so the idea is there's this
notion of conditional probability.
And the idea of conditional probability is
what's the chance something happens given
that we have already observed something
else has happened that might in some sense
change the chance of
the thing we care about?
That's referred to as conditioning on f.
If we wanna speak probabilistically.
And the way it's written is, we say,
what's the probability of E, and
we have a little bar and F as after it.
F is just some other thing
we've observed in the world and
the way we would say this is, what's the
probability that E will happen, some event
we care about, given that we've already
observed something else called F, okay.
So there's this little theorem, the
details in the theorem are not important,
we're actually gonna use this theorem
to do a couple of things in just a bit.
But there's a theorem that's due to Thomas
Bayes that we'll talk about that basically
says, if you have this probability,
what's the chance of E happening
given that F has already occurred?
Through some basic manipulations,
you could actually flip around that
probability say what's the chance F will
happen given that E has already occurred?
And you might say, but that's a little
bit weird cuz I've observed F,
and I care about E.
Well, sometimes it's actually easier
to think about what if E were true,
what would the chance of F be?
Doctors do this in diagnosis all the time.
I wanna see if you actually have
some particular medical condition.
I take a test, and so I say what's the
chance you have the medical condition if
the test were positive?
But it's easier to flip it around and
say what's the chance the test is positive
if you actually had the medical condition.
So that's the thing that's easier to
get from data from people we know have
the condition or not got the condition.
But we need this rule to be able to turn
it around to actually diagnose people.
And it turns out this becomes super
useful for decision making, okay.
So just to give you a simple example,
I could say what's the chance or
rolling a 10 on two dice?
Well, if these are distinct dice, the
chance or rolling a 10 on two dice turns
out to be 3 out of 36,
cuz there's 3 combinations of the dice.
Namely a 4 and a 6, and
a 6 and a 4, and 2,
5 which are 3 out of 36 possibilities
that would give you 10.
But if I know one of the dice already
rolled to 5, then all I care about is this
die coming up with a 5, which has a
one-sixth chance, so it becomes different
when I've observed some information
about one of the things involved.
And so I could get that from Bayes' Rule
by saying, what's the chance of rolling
a 10 and a 5 on the first die, that would
be getting a 5 here and rolling a 5 here.
There's only a 1 in 36 chance of rolling
that on two dice if I'm rolling them from
the beginning.
And then divided by the probability
of getting the thing I believe
I have previously observed,
which is getting the 5, okay.
So let's try an example with this first,
I'll tell you about Thomas Bayes,
in case you're wondering.
Thomas Bayes was a reverend
that lived in the 18th century,
British mathematician and
Presbyterian minister.
He also looked remarkably
like Charlie Sheen.
>> [LAUGH]
>> That's kind of the young svelte
Charlie Sheen, we won't talk about
the later Charlie Sheen, okay?
So where this gets interesting is we can
begin to apply this to some problems that
people actually do, and
then we'll do a little experiment, and
one of them is text analysis.
So here's an interesting concept, what if
we took the words that someone had written
and ignored the order in
which they were written.
And you would say, but that doesn't make
any sense, why would I ignore the order
of words, trust me if you've
read some student essays,
they ignore the order of the words too.
>> [LAUGH]
>> But let's just pretend.
And if we ignore the order of the words,
what's the probability of any
given word you write in English?
Well, how do we do that?
We could take a piece of writing
that someone has written.
Basically, we could cut it up
on little slips of paper so
every word's on a different slip of paper.
Put them in a big barrel, shake it up,
put our hand in, and draw out a word.
What's the chance we draw to
particular word like the or chair?
It depends on how many words
are actually in the barrel, and
how many times that particular
word is used in language.
So a simple example would be the word the
is much more commonly used than writing
than the word transatlantic.
So we'd expect the probability
of the word the to be higher.
Here we'd like to think
the probability of word Stanford is
higher than the probability
of the word Harvard.
There's [LAUGH] nothing wrong with that,
okay?
So we can measure the probability of
each word for someone's writing, but
here's where things get interesting.
Now, we can think about the different word
usage for different kinds of authors.
So someone, for example,
given that someone lives in California,
the chance they would write the word
sunny is probably higher than
someone who might live on the East Coast.
That's not to denigrate anyone on the East
Coast, thanks for visiting California.
It's just in writing,
that's what tends to happen.
So if that what tends to happen,
if you say given the writer,
that tells me the probability
of particular words.
You then think back to our
friend Thomas Bayes who said if
you have one probability,
I'll show you how to flip it around.
Which means now if I
don't know the writer,
I only know the words, I can determine the
probability of someone being the writer.
Which has actually been used to
deanonymize many things that have
been written anonymously in the past.
Let me give you an example.
The Federalist Papers.
Remember the Federalist Papers?
I don't know, like American history
somewhere back in high school,
it was a fun time.
Just to refresh your memory,
the Federalist Papers were 85
essays that were written about
the ratification of the Constitution.
They were all written under the pseudonym
Publius, turns out there was three people,
Alexander Hamilton, James Madison,
and John Jay who comprised Publius.
But they had written a bunch of
other stuff that luckily for us,
they'd actually put their name on.
So we could go to these fine
folks' actual known writings
analyze the distribution
of words that they used and
then use Bayes' theorem to figure
out who wrote which essays.
And we could actually also figure out that
there were a couple of essays that two
of them collaborated on because the
distribution of words used was actually
a combination of two different people.
I like to tell my students this because
sometimes they like to post stuff
anonymously online, and then they get
really disturbed when they see this, okay?
>> [LAUGH]
>> It turns out doing this kind
of analysis of word usage by people
is also something that you may
encounter every day in technology that
you use, for example, spam filters.
It turns out, in a spam filter,
a lot of people who sends spam,
are advertising things like Viagra.
The chance for the word Viagra appears
in an email that was written by you,
generally I would imagine,
is smaller than the probability
that it appears in a spammer.
And if you ever wonder how your email
system figures out what's spam and
what's not spam, it's actually using
a system like this to determine
probabilities of words and
messages that are sent to you and
then figure out should they
go on the spam folder or not.
So there are decisions being made using
this kind of technology whether or
not they're fully explicit or not.
And just to show you this little graph,
this is from Gmail if there's
any Gmail users out there.
The orange line is the percentage of all
emails sent through Gmail that's spam.
So this is a slightly historical graph cuz
I can't show you the latest numbers, but
that's approaching 80%.
It actually turns out the amount of
all email that's sent that's spam,
generally, is estimated
to be about 90% now.
So just wondering anyone get nine spams
for every one real email message you get?
If you do, you should change
your email address, okay.
But if you don't, the reason is that
blue line is the percentage of spam that
actually makes it through the system,
that's not detected.
Here is the interesting thing,
as the amount of spam goes up,
the percentage of spam that
gets through goes down.
And the reason for
that is that we have more data for spam,
we actually learn the characteristics
in the word usage in spam better, and
we can actually do a better
job filtering it out.
Okay, and this is actually used with
a bunch of different factors, okay.
So now we're gonna play a game for
which I have my illustrious volunteer.
We're born on the same day,
which is very exciting for me.
So there was this game show
called Let's Make A Deal.
Anyone remember Let's Make A Deal?
So back in the day, yeah.
When I say let's make
a deal to my students,
they're like what are you talking about?
>> [LAUGH]
>> But luckily,
some folks remember Monty Hall.
So here's how the game works.
There's three doors in the game.
Now it turns out they wouldn't let me
install three doors in this room, so
I have three envelopes.
And so what the host would do.
We have these three doors,
we'll call them A, B, and C.
Behind one of the doors or
inside one of these envelope is a prize,
and the other two are empty, okay.
And so what the host lets you do is
basically pick one of the doors,
in this case,
it will be one of the envelopes.
So you can choose one of the envelopes.
Feel free to pick whichever one you like,
okay.
Don't open it yet.
Now, all of them have a Green
sheet of paper and there so
is you don't go like this and
try to figure out what's inside.
But one of them also contains a portrait
of Andrew Jackson known as $20 bill, okay?
And so now, here's the interesting thing
what Monty Howard doing that makes could
deal, is Monti would open
one of the other two doors.
Right, so Monty opens one of the other two
doors, here's the green slip of paper, and
there's no money in there.
And then what Monty would
do is say all right,
there's one other door that's available.
Would you like to switch for that door?
Okay and so the question is, does it
make sense to switch for that door?
Okay so should we, how many people say
yes because you took a statistics class,
how many people say no, a few people?
How many people are in that indeterminate
it's the afternoon on a Friday I shouldn't
be making decisions, good?
>> [LAUGH]
>> So
let's look at this problem now with all
these tools that we've gotten to figure
out what's actually the right answer,
is there a right answer.
If we don't switch right so
if you keep the envelope that you have,
there is a one-third chance you win.
Because a prior you were given no
information you pick one of the envelopes,
let's say at random.
And assuming you don't
have psychic abilities,
you have a one-third chance of winning.
Now let's look at the possibilities.
So now to be sort of mathematical
we need to give everything some
letter designation.
So we're gonna call the envelope you
picked A, so that will be A, okay?
So now, there's three possibilities,
one possibility is that
A is actually the winner.
The chance that A is
the winner is one-third,
that's the chance you picked
the winning envelope.
And what would happen in that case?
If you picked A, and A was the winner,
I would be holding B and
C which are both empty.
So I could open up either one and
reveal to you an empty envelope.
And then if you were to switch,
you would be switching for
another empty envelope and
so you would lose.
And so the probability you win if
A is the winner and you picked A but
then you switched to zero cuz you're
switching to an empty envelope.
Now it doesn't sound so good.
So let's consider the other possibilities.
Let's say you still have A, so
the envelope you have is always A.
Let's say B is actually the winner now.
So B has a one-third chance
of being the winner.
So what does that mean?
You have A, I'm holding B and
C and B is the winner.
So I'm forced to open C,
cuz if I open B and say here's the money,
you wanna switch?
People don't like that game, so
what we're gonna do is I'm forced to
switch to open C because that's the only
envelope I have that I can show,
you're holding A and I'm holding B,
which is the winner in this case.
So if the probability you win,
given that B is the winner, and
you chose A but then you switch to
a guarantee to switch to B and win.
So the probability's one of winning.
And by symmetry if we consider
the case where C is the winner which
also has a one-third chance
you're holding A, I have B and C.
If C is the winner I'm forced to
open B which means if you switch,
you switch to C.
And so now what we need to do is add
up those three possibilities cuz
those are the three possible worlds
that exist given their probability.
So there's a one-third
chance A is the winner, and
then if you switch you get zero or
the probability of winning is zero.
There's a one-third chance
B is the winner, and
if you switch your probability
of winning is one.
And there's a one-third chance C
is the winner and if you switch,
your probability of winning is one.
When we add those together we get
two-thirds, so would you like to switch?
All right, all right, go ahead,
now, you can open it.
I hope this works.
>> [LAUGH]
>> Yay.
>> There you go, Andrew Jackson,
you can hold it up for everyone to see.
>> [APPLAUSE]
>> So
thanks for all those years of tuition,
you do get something back.
>> [LAUGH]
>> So
sometimes even then is hard for
people to see the solution for
this problem,
which is actually not out of the ordinary.
As matter of fact,
this problem originally,
it has much more,
longer statistical origins, but Marilyn
vos Savant was a woman who actually had
an advice column called Ask Marilyn.
And she posed this problem in there and
she said, you should switch.
Because it was a time when
Let's Make a Deal was on TV.
And a whole bunch of people, including
mathematics professors, wrote to her and
said, no, you're wrong.
How can you possibly do this?
And it turns out that Marilyn vos Savant
was actually in the Guinness Book of
World Records for
having the highest IQ of any woman.
She was right.
So this story itself actually has some
historical context to think about
the fact that when it's between math and
intuition and they collide the math wins.
So here's a slight variant
to clarify things.
What if instead of three envelopes,
I had a thousand envelopes and
I let you pick one, okay?
The chance you choose the winner
is one in a thousand.
But what would happen is,
there's nine hundred and
ninety-nine envelopes over here and
one over here.
This one you pick has
a one in thousand chance,
which means, of the remaining envelopes,
there's nine hundred and
ninety-nine out of a thousand chance
that the winner is over there.
Okay, what the host is forced to do
is open 998 of the envelopes, so all
the envelopes except for one, which means
if the winner came down this side there
are 998 envelopes that are empty that have
to be opened and then the winner remains.
What's the chance that the winner
came down this side, 999 out of 1000.
So in that case after opening those 998,
the probability of switching and
winning has to be, this
probability has to remain because this was
the chance the winner came down the side.
It just makes it more difficult
with three envelopes or
three doors because we have a situation
where we have a one-third probability you
picked a winner and two-thirds that
the winner came down this side.
So with smaller numbers it's harder to
see, but it's exactly the same problem.
Question?
>> It says it's conditional on the person
running the test,
knowing which envelope it is.
>> Yes, yes, yes, that's a great,
we should chat more,
are you a statistician by the way?
>> No.
>> No, all right but
there is an underlying, what is the actual
mechanics of the problem at play.
That's absolutely true and for
that I will lay this at your feet, because
you know the subtlety and the problem.
>> Thank you.
>> Could I ask that same
question on the one you first did,
which I'm still trying to work
through cuz I don't know the TV show.
>> Okay.
>> The reason it comes out the way it does
is because the host has to know which is
which, and so it's not really random.
>> Exactly, the host-
>> He's sort of
revealing something when they [INAUDIBLE]
>> Absolutely, so
the issue is that the host is
constrained to open an empty door.
The host is not picking randomly.
>> [INAUDIBLE] to do that on the show,
I'm just curious now.
>> Well I'll tell you when I was a kid and
I used to watch that show,
I used to always sit there going don't
switch, don't switch, don't switch.
And I didn't actually count but I did
this demonstration for some high school
students and much to my shrug grin,
the student who picked the envelope.
All the other students in the class
said don't switch, don't switch and
I got these shades of when I was a kid and
then it turned out he didn't
have the winner anyway.
So you know the math and
intuition collide, the Math wins and
I told him that but he was pretty sad.
>> [LAUGH]
>> So
should you switch the chance of winning is
one over the number of original envelopes.
And if you switch it's the number of
original envelopes minus 1 divided by
the total number of envelopes, okay?
And it just turns out the one-third,
two-third case is sometimes
harder to see that.
So one of the other things we can think
about in terms of decision making is when
we wanna make a decision, what do we
expect to get from that decision, okay?
And part of the ideas what we refer
to as expected value which is
a statistical concept.
Let's say we have some variable
that we're gonna call x,
which represents the result of
rolling a die, six-sided die.
And we wanna say what's
the expected value.
The expected value is basically just
a way of saying what's the average
we would expect.
So we have some probability
of different outcomes.
We take every possible outcome,
that's little x.
So there's, all the little x's are all the
little possible outcomes one through six
and we multiply each one of them by the
corresponding The corresponding values,
1 through 6, by the chance of
that value coming up, okay?
So I'll show you this explicitly for
a six-sided die in just a second, but
that's the notion of expectation.
You could also think of it as average,
or the weighted average, if this was not
a fair die, if the different sides came
up with different probabilities, okay?
So it's also referred to as the mean,
which some of you may know
from exams back in the day.
And the way we could compute it is,
we basically say for a six-sided die,
the chance of any outcome, 1 through 6,
is all equally likely, is one-sixth.
So what's the average value of a roll?
The average value of a roll says, take the
chance of rolling a 1, multiplied by 1.
Add to it the chance of rolling a 2,
multiplied by 2,
the chance of rolling a 3,
multiplied by 3, etc.
In this case, all the probabilities,
the chances are the same, but
what we get is seven-halfs or
3 and a half.
Which is weird because we can't
actually roll a 3 and a half.
But if you think about us
rolling this over and over,
what's the average value over all
those roles, is 3 and a half, okay?
So, that's expectation.
Now we can take this and
apply it to situations were there's
some uncertainty and some payoff,
it's not just a die role.
We could say, let's say I have
a coin to flip, and I say,
if this coin comes up heads you win $5,
and if it comes up tails, you lose $2.
[CROSSTALK] And it's a fair coin.
>> There you go,
someone knows the probabilities involved.
Sorry, I'm also really bad shot.
So we can define this,
look at this mathematically, and
say let Z be our winnings, okay?
What's the average winnings
of playing this game?
And so if we think about the average
winnings, what we say is it's
one-half the probability of getting heads,
times the outcome, which is we win $5.
Plus one-half the prob,
which is the probability of getting tails,
times the outcome when we get tails,
which is negative $2.
And we just multiply and add, and
we get the average payoff of the game is
positive $1.50, so it's worth playing.
>> So if you wanna lower the variance, you
can just pay me a buck 50 right now, and
we'll call it even.
>> [LAUGH] Yeah we can play over and over,
if I brought that kinda cash with me.
But we will play another
game in just a bit.
And so we can begin to think of this idea,
to think about different decisions and
the possible outcomes,
the possible payoffs, by using what's
known as the probability tree.
And a probability tree is just a graphical
way of representing a decision.
So we could say, flipping a coin, there's
two branches, there's two possibilities.
The coin with probability
p comes up heads.
And with probability 1- p,
it comes up tails,
cuz the two probabilities added
together have to add up to 1, okay?
So, let's consider the decision
to play a lottery.
So what we can do is,
we can say do you buy the ticket or not?
You have a choice, yes or no.
If you don't buy the ticket, you don't
win anything, you don't lose anything.
If you do buy the ticket,
then you're entered into the lottery.
There is some probability
p you win the lottery,
some probability 1- p
you lose the lottery.
And if the lottery pays off $1 million,
in the case where you win,
which has probability p,
your payoff is $1 million- 1.
Why is there a- 1?
>> [INAUDIBLE]
>> We gotta buy the ticket, right?
Tickets are not free, so we- 1 for the
ticket, and if you lose the lottery, so
you decide to play but the outcome is
that you lose, you just lose your dollar.
And so
the question is should you play or not,
you can look at what is the expected
value in those two outcomes.
Your expected value, there's no
uncertainty if you choose no, so
it's just 0.
Your expected value if you choose to play,
is your probability of winning
times the payoff of winning,
plus the probability of losing,
times the value of losing.
If we think about that, we can think about
how much value does that have to you?
And that's something known as utility.
Utility is basically the value of
some choice to you as an individual.
And, so
let's say we have two possible choices,
we can make, like buying a ticket,
or not buying a ticket.
Each possible choice has some set
of consequences associated with it.
Not buying a ticket only has one
consequence, which is you don't win and
you don't lose anything.
Buying a ticket has two consequences,
you win the lottery or you don't.
And each consequence has some probability
or chance of happening, okay.?
Utility says, how much value do you get
if a particular consequence happens,
and how much is that worth you?
And we'll talk about that
explicitly in just a second.
So buying the $1 ticket, in a prize with
$1 million payoff, if the probability of
winning, if that p is 1 over 10 million,
or 1 to the 10th to the 7th power.
Buying the ticket has two outcomes,
win or lose.
The utility of winning,
assuming for right now,
that you just think of
the monetary value for you.
Is a million- 1 in the case where you win,
negative 1 in the case where you lose, and
if you don't buy the ticket,
it's just 0, cuz you don't win or lose.
And so the expected value, basically,
if you were to look at the payoff in the
case where you win, times the probability.
Multiply or and then look at the case
of not winning versus the payoff there,
the lotteries, on average,
are worth about negative $0.90, okay?
In California they like to have the
slogan, you can't win if you don't play,
and a more accurate slogan would be,
basically,
you can't lose if you don't play.
>> [LAUGH]
>> Okay.
But let's bump this up a notch, okay?
x is the value you derive from
that particular thing, right?
It doesn't have to have
the actual dollar value.
So, let's consider
a slightly different game.
Let's say I gave you this choice.
I'm not really gonna give you this choice,
I wish I could, but I'm not.
You can choose to either play a game or
not play a game.
If you play the game, I will flip
a fair coin, and with half likelihood,
if it comes up heads, you win $20,000,
otherwise you win nothing.
If you choose not to play the game
you just get $10,000 guaranteed.
How many people would play the game?
How many people would not play the game?
>> [INAUDIBLE]
>> We're playing it once.
We play once.
>> I get $10,000?
>> If you say I don't wanna play,
you just get $10,000.
>> If I don't wanna play?
>> If you don't wanna play.
So how many people don't wanna play?
Wow, almost everyone.
But the expected value of that game should
be 50% times $20,000, which is $10,000.
So we would think the room
would be split 50/50,
why did the room all skew to one side,
okay?
Because the value you get from the money
is actually the utility of $20,000,
or the utility of $10,000, and
there is not necessarily a linear
relationship between those two things.
So $20,000, to most people, is not
equivalent to 2 times the initial $10,000.
Because, that $10,000 may actually
have a bigger impact on their life,
than thinking about gambling
with the additional 20 to
get the additional 10,000 I'll make
that explicit in just a second, okay?
The other thing that sometimes
I talk to doctors about this,
is that these kind of decisions
actually not just involve money, but
more importantly, they involve
factors like quality of life, right?
And how do you trade those things off,
right?
There's a medicine you can take
that may have a 10% chance
of curing the condition and
a 90% chance of being fatal.
How do you weigh that over thinking about
the uncertainty that there might only be
a few days left, right?
I don't wanna be morbid,
that's a little too morbid.
Let me pop-up from being morbid, but
that's the kind of thing, when I talk to
doctors, that they're trying to ascertain.
So let's pay another game.
Now this game, that if you choose to play,
we will flip the fair coin,
and if it comes up heads you get $1,000,
if it comes up tails you get nothing.
You can choose not to play, in which
case you will get a guaranteed payout.
And the question is,
how much does that payout have to be, for
you to be indifferent between
playing in the game or not?
So think of it this way,
so indifferent, so
the way you can think about indifference
is, say I put some value for x like $300.
You would say, you know what, to me it
doesn't matter if you just gave me $300 or
you entered me into this gamble for
a 50% chance to win a 1000.
To me that's really the same,
someone else could make that decision for
me and
I would be fine whichever way they choose.
So that's true indifference, right?
You could give the decision
to someone else, and
you are fine with either decision, okay?
So, how many people would choose to play
the game if x, the guaranteed payout,
was $300?
Raise your hand and keep them up.
>> Wait, to?
>> To play the game.
>> I thought you were asking.
But at this point I still want
to see if you want to play.
So you're not indifferent.
You're willing to play the game.
Just take a chance.
So what if I raise it to 400?
How about 500?
Anyone still playing at 600?
There's one hand on the back.
You're known as risk preferring.
Right, you should go to Vegas right now
because they'll give you better odds.
Okay, notice there's different hands
going up in different time in the room.
That's not by accident and
it doesn't mean that anyone is wrong.
Everyone is right because
to different people,
this gamble is worth
different amounts of money.
Everyone has a different utility function.
But the thing that a gamble like
this allows you to ascertain
is how much is the uncertainty
avoidance worth to you, right?
So, that's the weird thing to think about.
Uncertainty itself,
the probability that something will
happen has monetary value to get rid of.
Because this is what's known
as the certain equivalent.
It's the idea that if I were
to have played this game, that
if I were to actually choose yes to play,
the expected value of the game is $500.
I'm potentially willing to take less
than $500 because I want it guaranteed.
I want to avoid uncertainty, okay?
Which tells you how much that
uncertainty is actually worth
to you as a monetary figure,
which is a little bit weird.
Okay, so the certain equivalence's
potentially different for everyone.
That's perfectly fine,
it's what your value is.
So let me give you an example.
Let's say we have this choice between
playing a game for $20,000 or 0, right?
Flipping the fair coin or someone could
say I will give you $80,000 guaranteed.
And someone say was really indifferent
between those two prospects.
Sorry, 8,000.
8,000, that's our certain equivalent.
The expected monetary value of
the game is what we get when we
compute that expectation thing for
the game.
It's just 50% times 20,000,
plus 50% times 0, which gives us 10,000.
That's the value of
the game in expected value.
But our certain equivalent
is less than that.
So there's actually something called
the Risk Premium, it's how much we
are willing to give up in terms of
monetary value to avoid uncertainty.
So in this case,
we're willing to give up $2,000 of
potential value just to avoid risk, okay?
And if you're wondering,
do people do this?
Of course we do this all the time,
it's called insurance.
Okay, so let's consider
a simple example of insurance.
In California, you're required to buy it,
in some states, you're not.
But let's consider a simple example,
you can choose to insure your car or not.
If you insure your car,
you pay $1,000 to insure it for that year.
And let's just say it's totally
comprehensive insurance.
You get into a collision,
something happens,
they just pay for replacing the car,
pay for any damage.
Or you can choose not to pay for
insurance and you're uninsured.
There's a like high chance
nothing happens, right?
You drive along, there's no accident,
there's no money you have to pay
either for an insurance premium or
to fix anyone's car.
There is a small chance
you get in an accident and
let's just assume in that accident
all that happens is car damage,
so no one's actually injured but
$30,000 of car damage.
So you look at that say, what's the
expected value of not buying insurance?
It's negative $600, right?
It's that 2% times the negative 30,000.
What's the expected
value of the insurance?
It's less than that.
We're paying the $1,000 guaranteed.
Most of us choose to buy insurance.
Why?
Cuz we wanna avoid that risk, okay?
Turns out actually something,
not fully understanding this modulo,
a few other things about making
assumptions, about probability what many
people believed was one of the causes for
the housing crisis in 2000, okay?
And if you were interested in that,
we can talk about that offline.
But I won't go into more detail.
But it has to do with how
we think about risk and
how risk is spread out over
multiple possible factors, okay?
We also have a non-linear appreciation for
money, which I talked about before,
this utility thing.
Okay, so let's play a simple,
or we're not going to play it.
But let me ask you for the simple game.
Coin flip comes up heads, you win $10,
otherwise you get nothing.
Or I will give you $2 guaranteed.
How many people would
choose to play the game?
How many people take the $2?
Couple of people, very few.
Now I'm gonna take those exact same
figures and make a linear transformation,
which just means I multiply
them all by some value.
I'm gonna multiply them all
by the value of 10 million.
>> [LAUGH]
>> Okay, so you can take the coin flip for
100 million or nothing, or
you can take $20 million guaranteed.
How many people wanna
take the coin flip now?
>> [LAUGH]
>> One person, all right,
we're going to Vegas.
We're.
>> [LAUGH]
>> And the reason is is that the amount of
change in someone life that
happens by getting $20 million and
having certainty around that is worth
much more than the potential for
another 80 million, all right?
Event hough the expected
value of this game.
Sorry about that.
The expected value of that
higher game is worth more.
It's because that extra 80 million won't
significantly change our life in a way
that the first 20 million
won't have already done.
And get rid of a bunch of worries for us.
And that's one of the things we wanna
think about is that when we make these
kind of decisions,
thinking about the non-linearity
of how we value these things
makes a huge difference.
There's these things called utility
curves and risk profiles, and
the basic idea is if you're risk neutral,
which very few people actually are,
the first $50 of, I'd say think of this
graph as being utility versus dollars.
The value of the first $50, the size of
that bar as the same as the next $50.
Most people are not like that,
most people are Risk Averse.
The second $50, so
going from 50 to a $100,
has less value to them than the first $50.
And I feels like it's hard to imagine
this with $50, make it 50,000.
Make it 500,000, okay?
And then it becomes more clear for
each individual,
depending on their utility curve,
why the next increment of the same
amount of money is not worth
the same as the first amount.
There are some individuals
that are Risk Preferring.
They tend to really like gambling
cuz the second $50 is worth
more to them than the first $50.
And so if they can take an even, fair
bet that's 50 50 to win that second $50,
they're likely to do it.
But there's very few people
like that in the world.
I shouldn't say very few people,
there is a small number, okay?
So, I need another volunteer.
Come on down.
So, here's Thomas Bayes asking for
another volunteer.
So, what we are gonna do is we're gonna
play a slightly different game than
what we had before.
So before we had three envelopes.
This time, I'm gonna have two envelopes
and I'll allow you to have one.
I'll tell you the set up for the game.
One of these envelopes contains $X.
We don't know what X is but
one of the envelopes contains $X,
the other contains $2X.
So one has double the amounts
as the other envelope.
Pick an envelope.
All right, don't open it yet.
So you have your envelope, okay?
So you selected an envelope.
I will give you an opportunity to switch.
Do you wanna switch?
Does it make any sense to switch?
No.
At this point,
we have complete uncertainty.
You have 50% chance of getting
either one of the envelopes,
50% chance of the other envelope, okay?
Now, go ahead and open the envelope.
>> [LAUGH]
>> So open up the green paper, that's so
you can't hold it up to the light.
What's in there?
>> $20 bill.
>> $20 bill.
Now, would you like to switch?
>> [LAUGH]
>> So let me help you out with this,
right, cuz it's sorta like
I'm putting you on the spot.
And i know it's kind of rough,
it's a Friday afternoon,
you're in front of like 250 people,
let me help you out.
Okay, so let's say y is the amount of
money in the envelope you picked, right,
so we're just gonna call that y.
So how much, what would we expect
is in the other envelope, right?
So what you have y.
What we expect in the other envelope is
one half chance that there's y over 2,
right?
>> 45.
>> Well, so let's just do-
>> I mean 50, sorry.
>> Yeah, so we'll go one step at a time.
So you're ahead of me, that's really good.
But I'm gonna go a little bit
slower cuz I move a little slower.
So I have 50% chance the other
envelope has half as much.
And I have a 50% chance the other
envelope has twice as much.
So when I multiply these together,
this gives me a y,
and this gives me a one-fourth y.
One-fourth y,
which gives me five-fourths y.
Which is strictly greater than y,
for any positive value of y, right?
Which means, if you have $20,
the other envelope is worth $25.
Should you switch?
>> Depends, am I risk-averse,
risk-neutral, or risk-liking?
>> Yeah
>> I would say, how about, no.
>> You could say no,
that's perfectly fine.
Okay, let's say you were risk-neutral.
So let's say, that actually all dollar
values, at least in this range, so
there is some small range of dollar values
that people are actually risk-neutral in.
So let's say you're risk-neutral.
Would you wanna switch?
>> Yes.
>> Okay, now here's the question.
That envelope, before he opened it,
I could have written y on front of it, and
that would have been this y.
And this envelope would suddenly
become worth five-fourths y.
So before even revealing how much is
in the envelope, as soon as you picked
an envelope, I could make the claim
that this envelope is worth more.
But before we opened anything,
it was like, it's not worth it to switch.
So what happened?
Okay, I got really disturbed,
that's what happened.
>> [LAUGH]
>> All right,
this is one of those things where,
when we think about the probabilities,
risk aversion, you're absolutely right.
It's first thing we wanna think about,
in terms of potential payoff we get.
The other thing we want to think about is,
what is a probability, okay?
Which is a very, it turns out,
interestingly enough,
when we talk about probability.
People talk about, they're like,
it's a mathematical concept,
we should know what probability is.
There are two different schools of thought
around what a probability actually means,
in some semantic sense, which is weird,
when I tell my students that,
they freak out.
They're like, it's math Marin,
it's numbers,
what do you mean there is
different interpretations.
One of the interpretations of probability
is basically just, you see something
happen over and over, and
that's how you determine the probability.
I roll this die a million times, figure
out what fraction of the times I rolled
a one, and
that's the probability of getting a one.
If I were to roll the die
infinitely often,
that's called frequent disprobabilty.
There's another form of probability
called Basesan probability, which is
named after our little friend Thomas Bays,
that says all probability is, is a belief.
And if you think about that,
I can ask you,
what's the chance it's
gonna rain tomorrow?
Most people would say,
maybe, I don't know, 10%?
Have you seen infinitely many
tomorrows to make that determination?
No, we haven't seen any of them.
But how do we make that ascription?
Well, we've seen the general weather
pattern on that particular day for
many years in the past.
But it's not the actual day tomorrow.
So, in one level of interpretation,
a probability is just a belief, and
part of that belief comes down to,
what values do you think I would
put in the envelope, right?
I'll would bet you would be shocked
if you open one of the envelopes,
and you're like, you put a million
dollars in this envelope.
I don't care about switching,
I'm just leaving, can I keep it?
>> [LAUGH]
>> Right,
but that's probably not something
you believed beforehand.
And so the issue with this,
before you open the envelopes,
is either one is actually equally good,
okay?
But what happens when we actually open
the envelope and put the value down,
is this little equation I gave you here,
is actually not true, okay?
Despite the fact that it looks true, and
it's easy to sorta take
you through that exercise.
Here's is what's actually is going on.
So the setup again,
you know there's one that has x dollars,
one that has 2x dollars, okay?
And I give you this garden path equation,
because it's leading
you to the wrong place.
The problem would actually happen
when you open the envelope.
Is for this equation to be true,
you have to believe that the other
envelope really is equally likely
to have twice as much money or
half as much money, no matter how much
is in the envelope you pick, okay?
And so if you pick an envelope
that had a million dollars,
you're like, man, either Stanford's
really paying well these days, or
this guy's probably not gonna put
2 million in the other envelope.
It's probably more likely that
he would put half a million.
[LAUGH] Probability is 0 I'm putting
either of those amounts in there.
>> [LAUGH]
>> But mathematically,
what it actually means is, if you assume
that any possibility of twice and
half was equally likely, you would
basically be saying on the number line,
there is equal probabilities for
all values from 0 to infinity.
And I need to be able to integrate that,
and have it integrate to 1,
because all the probabilities
have to sum to 1.
There's no constant value,
just to bring back shades of calculus.
There's no constant value greater than 0,
that I can integrate from 0
to infinity that equals 1.
So this thing can't exist,
this equation can't exist.
So the only thing that can exist is,
we have to assign for
ourselves what those probabilities are,
okay?
So, if that's the case,
then we have this subjective belief
about what's in the envelope, right?
So we can't say all values
are equally likely,
that's not a true
probability distribution.
And so the frequentist,
that interpretation says,
well you play the game infinitely often,
and
see what values Marin
puts in the envelope.
I'm not going to play the game infinitely
often [LAUGH], cuz I just lose every time.
>> [LAUGH].
>> That's the problem,
is I only let you play once.
What the Bayesian says is,
I have a prior belief.
A priori I believe, you know what, there
is probably some distribution where I
saw him do the 20 with
the Monte Hall game before.
Maybe the chance that he puts a $20 bill
in there is like, I don't know, 20%.
And so the chance of, that he's actually
gonna put $40 in there, I might say,
is actually only like 5%.
So the chance he might put $10 in
there is probably like 50%, and so
you come up with some distribution.
And once you have that distribution,
what actually happens when you
open the envelope is, you see where
on that distribution you are.
And now,
given the probabilities that you have,
which might also get updated slightly,
because when you see what value it is,
you think, he's willing to give more or
less money.
Then you can do the math of multiplying
the probability times the payoff in
choosing the other envelope.
So with all that said,
do you want to switch or keep it.
>> [LAUGH]
>> I'm gonna stay with, I might keep,
I'm keeping it.
>> You're gonna keep the 20, awesome.
All right, so I could tell you
what was in the other envelope.
>> Was it a 20 to make the story worth it?
>> No actually, you made a good choice.
Cuz the other envelope has $10 in it.
>> [APPLAUSE]
>> Well done.
>> [APPLAUSE]
>> You can keep the 20, but
i would like the envelope and
the green paper back.
>> [LAUGH]
>> Thank you.
So, here is another way to think about it.
What the Bayesian would say is,
I have this distribution over the values.
And I'll make it really concrete for
you, okay?
What they would do is, when they have the
distribution over values they would say,
once I open the envelope, I can now think,
what was my expected value, based on
my distribution, versus what I saw?
So, is it actually more likely that
there's $10 in there versus $40,
multiplied by the probability
to get the expected value?
Here is an easy way to think about it.
What if you opened the envelope, and
instead of $20 in there, there was $20.01.
>> [LAUGH]
>> Would you switch or not?
>> Switch.
>> Yes,
>> Why would you switch?
>> [INAUDIBLE]
>> The dreaded half cent.
What about the half cent?
And you're like, but actually Marin,
half cents were stop being minted in 1865.
And if I got one in good condition,
it'd be worth about $150.
So I'm switching no mater what.
Notice the amount of, without even
knowing about half cents, the amount of
information you bring to bear in that
problem without thinking about it, right?
So if there's $20.01, you say, I should
switch because one, there isn't gonna be
half cents, or if there are,
maybe they would actually be worth more.
But i never told you that the dollar
values in there couldn't be some fraction.
I never told you that it had to
be US currency until you actually
opened the envelope.
I never told you that these
weren't possibilities,
that there had to be interval quantities.
And there, some people say, but
you wouldn't put change in there.
Like if it was $20.02, you wouldn't
put change cuz, then I could shake it.
I never told you any of those things.
All of those assumptions were part
of your decision making process that
led to the decision that said, if there's
$20 in one sense I should switch.
And that's the other thing about decision
making, is not only the probabilities, but
understanding what are the implicit
assumptions we actually use to make those
decisions when we think about the set of
options that are actually available to us.
Which could be larger
than we otherwise think.
Okay?
So, let me give you one last problem.
So, just to in your Friday afternoon,
you might leave a little disturb to
wonder how rational you actually are.
Okay?
So, I'll give you 2 different choices and
you can pick 1 option for each choice.
So, choice number 1,
you have 2 options, A and B.
So, option A,
you got a million dollars guarantee.
Option B there is an 89% chance
you get a million dollars,
a 1% chance you get nothing and
10% chance you get $5 million.
So go ahead and choose.
Don't say that aloud, just choose that
in your head which one you would choose.
Okay?
Option 2, not so
nice not guaranteed options.
So you have a choice for C and D.
Where C says there's an 89% chance of
nothing and an 11% chance of $1,000,000.
And D says a 90% chance of nothing and
a 10% chance of $5,000,000.
So go ahead and decide for yourself
which one of those 2 you would choose.
Okay, how many people chose A and C?
B and C?
[INAUDIBLE]
>> Okay go ahead.
>> [LAUGH]
>> I know is a tough decision.
>> [LAUGH]
>> Okay.
[COUGH] [COUGH]
>> You got your choices?
Got them?
All right.
Anyone choose A and C?
Few folks.
Anyone choose B and C?
How about B and D?
Fair number.
How about A and D?
All right so we got kinda a split
between B and D, and A and D.
Interestingly enough if you chose A and D.
You are irrational.
>> [LAUGH]
>> For any choice of utility function.
Doesn't even matter how you value money
as long as you value it as non-zero.
>> [LAUGH]
>> Why?
So let me show you mathematically
why this is a case and
then I'll show intuitively why
psychologist say this is the case.
So mathematically, if we prefer choice
A to choice B, then we would prefer
100% chance of the utility of $1 million
would be greater than 89% of the utility
of a million plus 1% of the utility of
0 plus 10% of the utility of 5 million.
So now I'm gonna do,
is look at that same thing for choice D.
If I make choice D, what I'm saying is
that the utility of 89% of the utility of
0 plus 11% of the utility of a million
is less, cuz I didn't choose C
then 90% of utility of zero plus
10% of the utility of 5 million.
Now I'm gonna do a little Math.
So I start of with choice D and
I'll say hey,
I have a little equality subtract 89%
of the utility of 0 from both side.
Okay, so I'll eliminate the 89%
of utility of the 0 on top,
on the bottom I'll have
now 1% of utility of 0.
Then I say go ahead and add 89% of
the utility of $1 million to both sides.
So I do that and
so the 11% of the utility a million
becomes 100% of the utility of a million.
And I also add an 89% to
the utility of a million.
And I have the boxes for
choice D up there just rewritten.
And choice A that looks super similar.
Except for the fact that one is greater
than and the other is less than, okay?
So the choices are inconsistent, okay?
And that's for any choice utility
the function cuz I didn't tell you what
the utility values were I just did
it at the function of utility.
Why is that?
Why do we make those decisions?
Okay, so
there is this thing called 'Lay Paradox'.
Thanks to Mary Suley,
who is a French economist,
who actually won the Noble Prize.
But the reason for this, is that
essentially what this boils down to,
is we value certain D more than its worth.
Okay.
So in the first choice,
when there is a 100% chance of A,
when we choose A,
we say that's a million dollars and
I know there's this 1% chance
I might lose in there.
There's even a 10% chance I
might get 5 times as much.
But if I were to lose I'd have so
much regret and
I don't wanna do it that I
want the guaranteed win.
Well guess what's going on with
the choice between C and D.
In order to get the 5 times payoff,
you are giving up a 1%
chance of winning anything.
So it's that same 1% chance which
makes it 1% more likely you
will get 0 in the case for D.
That's exactly the same 1% as getting
that 1% in the first case of getting 0.
But in the first case the situation is
framed as certainty verses uncertainty and
in the second case both decisions have
uncertainty associated with them and so we
don't value you them the same even though
they should be by some normative rule.
Okay.
And that's what psychologists
say will happen.
They will say that we tend to
over value certainty in life.
When it actually exists.
So to wrap up, I would just say decision
making often occurs under uncertainty.
There's these probabilities out there.
But if we can somehow understand
the decisions that we're making from
the standpoint of
understanding probability.
And the expected value we get, and
the hidden assumptions we make when we
make those decisions, and what's really
important to us at the end of the day,
hopefully we can make better decisions.
And remember, not all decisions
are subject to decision analysis.
So thanks very much for coming.
>> [APPLAUSE]
