Revealed preference, is a theory offered by the American economist Paul Samuelson in 1938. The theory asserts that consumers’ behavior – assuming a constant income and an item’s price – is the best indicator of their hidden preferences. In short, that is how people reveal what they really want.
For the sake of this article, we’ll leave out the pure economics definition of revealed preferences to insert it into a new theory of rationality. Let’s start with Nassim Nicholas Taleb’s view of revealed preferences.
Taleb’s view on revealed preferences
The axiom of revelation of preferencesstates the following: you will not have an idea about what people really think, what predicts people’s actions, merely by asking them –they themselves don’t know.
There is no such thing as “rationality” of a belief, there is rationality of action
The rationality of an action can only be judged by evolutionary considerations
This theory of rationality moves around a few key points which can shift your perspective and make you a better business person.
Science and scientism
As science has been so successful in certain fields (take physics) over the centuries, we matured the belief that scientific principles developed by hard sciences could be applied to soft sciences, or to human nature in general.
This belief brought to the rise of scientism, or the core belief that things could be stripped from their “irrational” part to make them rational.
Here rationality, though, is measured in terms of beliefs rather than the actions that come from those beliefs.
And this is the primary fallacy scientism falls into.
A person imbued with scientism will criticize religion, yet she will believe in economic theories that narrow down reality to a model that is not only far from it, but that from the collective standpoint might have negative consequences for society overall.
Domain dependence
Understanding that the scientific method can be used in certain fields, but it loses value in other domains, is critical. In the realm of human, messy affairs, it is essential to have a different mindset. While experimentation, it’s still the key, it will have a different meaning.
Experimentation won’t be tied to a narrow domain, but close to creativity and the ability to draw ideas from fields and domains that are far off from the one where you’re trying to apply a solution. Thus, it will require a broad range of creativity, a lot of experimentation, and the ability to have a broad spectrum of experiments.
Rationality based on survival of fit actions
Your eyes are not sensors aimed at getting the electromagnetic spectrum of reality. Their job description is not to produce the most accurate scientific representation of reality; rather the most useful one for survival.
Still, in his article “How to be Rational about Rationality,” Taleb highlights how eyes are wired to survival rather than giving an accurate or scientific representation of reality.
This view highlights how rationality is not about logical explanations. As many things in the real messy world can’t be explained, as there is a hidden meaning, which might not be revealed.
We need to trust more the subconscious side, which calls up to look us for actions that survive time, rather than explanations and how those might fit the current context or prevailing intellectual view.
Skin in the game
What matters, in the end, is what they pay for goods, not what they say they “think” about them, or what are the reasons they give you or themselves for that. (Think about it: revelation of preferences is skin in the game).
Another core concept connected to this revealed preference view is that of skin in the game or the fact that in order to reveal what people really want.
One way is to have them pay for something, as this implies an action, which isn’t frictionless, thus if performed might reveal strong subconscious preferences, hard to explain rationally, but work as a strong hidden signal.
Beliefs are cheap; actions do cost
For beliefs are … cheap talk. A foundational principle of decision theory (and one that is at the basis of neoclassical economics, rational choice, and similar disciplines) is that what goes on in the head of people isn’t the business of science. First, what they think may not be measurable enough to lend itself to some scientific investigation. Second, it is not testable. Finally, there may be some type of a translation mechanism too hard for us to understand, with distortions at the level of the process that are actually necessary for think to work.
For the sake of understanding this theory, it’s essential to look at actions!
Key takeaways
Revealed preferences can help us uncover what people really want.
Revealed preferences are about what people do when they are skin in the game.
It’s also about rationality meant as the survival of actions that gain us fit in the real world.
It’s not about elegant theories or beliefs, but it’s about those beliefs that lead to actions that make the collective survive.
In short, that is about uncovering hidden cues from the subconscious mind, so that we avoid attaching rationality to things in hindsight.
Convergent thinking occurs when the solution to a problem can be found by applying established rules and logical reasoning. Whereas divergent thinking is an unstructured problem-solving method where participants are encouraged to develop many innovative ideas or solutions to a given problem. Where convergent thinking might work for larger, mature organizations where divergent thinking is more suited for startups and innovative companies.
Second-order thinking is a means of assessing the implications of our decisions by considering future consequences. Second-order thinking is a mental model that considers all future possibilities. It encourages individuals to think outside of the box so that they can prepare for every and any eventuality. It also discourages the tendency for individuals to default to the most obvious choice.
Systems thinking is a holistic means of investigating the factors and interactions that could contribute to a potential outcome. It is about thinking non-linearly, and understanding the second-order consequences of actions and input into the system.
Vertical thinking, on the other hand, is a problem-solving approach that favors a selective, analytical, structured, and sequential mindset. The focus of vertical thinking is to arrive at a reasoned, defined solution.
First-principles thinking – sometimes called reasoning from first principles – is used to reverse-engineer complex problems and encourage creativity. It involves breaking down problems into basic elements and reassembling them from the ground up. Elon Musk is among the strongest proponents of this way of thinking.
The ladder of inference is a conscious or subconscious thinking process where an individual moves from a fact to a decision or action. The ladder of inference was created by academic Chris Argyris to illustrate how people form and then use mental models to make decisions.
The Six Thinking Hats model was created by psychologist Edward de Bono in 1986, who noted that personality type was a key driver of how people approached problem-solving. For example, optimists view situations differently from pessimists. Analytical individuals may generate ideas that a more emotional person would not, and vice versa.
Second-order thinking is a means of assessing the implications of our decisions by considering future consequences. Second-order thinking is a mental model that considers all future possibilities. It encourages individuals to think outside of the box so that they can prepare for every and eventuality. It also discourages the tendency for individuals to default to the most obvious choice.
Lateral thinking is a business strategy that involves approaching a problem from a different direction. The strategy attempts to remove traditionally formulaic and routine approaches to problem-solving by advocating creative thinking, therefore finding unconventional ways to solve a known problem. This sort of non-linear approach to problem-solving, can at times, create a big impact.
Moonshot thinking is an approach to innovation, and it can be applied to business or any other discipline where you target at least 10X goals. That shifts the mindset, and it empowers a team of people to look for unconventional solutions, thus starting from first principles, by leveraging on fast-paced experimentation.
The concept of cognitive biases was introduced and popularized by the work of Amos Tversky and Daniel Kahneman in 1972. Biases are seen as systematic errors and flaws that make humans deviate from the standards of rationality, thus making us inept at making good decisions under uncertainty.
Bounded rationality is a concept attributed to Herbert Simon, an economist and political scientist interested in decision-making and how we make decisions in the real world. In fact, he believed that rather than optimizing (which was the mainstream view in the past decades) humans follow what he called satisficing.
The Dunning-Kruger effect describes a cognitive bias where people with low ability in a task overestimate their ability to perform that task well. Consumers or businesses that do not possess the requisite knowledge make bad decisions. What’s more, knowledge gaps prevent the person or business from seeing their mistakes.
The Mandela effect is a phenomenon where a large group of people remembers an event differently from how it occurred. The Mandela effect was first described in relation to Fiona Broome, who believed that former South African President Nelson Mandela died in prison during the 1980s. While Mandela was released from prison in 1990 and died 23 years later, Broome remembered news coverage of his death in prison and even a speech from his widow. Of course, neither event occurred in reality. But Broome was later to discover that she was not the only one with the same recollection of events.
The bandwagon effect tells us that the more a belief or idea has been adopted by more people within a group, the more the individual adoption of that idea might increase within the same group. This is the psychological effect that leads to herd mentality. What in marketing can be associated with social proof.
The PESTEL analysis is a framework that can help marketers assess whether macro-economic factors are affecting an organization. This is a critical step that helps organizations identify potential threats and weaknesses that can be used in other frameworks such as SWOT or to gain a broader and better understanding of the overall marketing environment.
The STEEP analysis is a tool used to map the external factors that impact an organization. STEEP stands for the five key areas on which the analysis focuses: socio-cultural, technological, economic, environmental/ecological, and political. Usually, the STEEP analysis is complementary or alternative to other methods such as SWOT or PESTEL analyses.
The STEEPLE analysis is a variation of the STEEP analysis. Where the step analysis comprises socio-cultural, technological, economic, environmental/ecological, and political factors as the base of the analysis. The STEEPLE analysis adds other two factors such as Legal and Ethical.
Porter’s Five Forces is a model that helps organizations to gain a better understanding of their industries and competition. Published for the first time by Professor Michael Porter in his book “Competitive Strategy” in the 1980s. The model breaks down industries and markets by analyzing them through five forces.
A SWOT Analysis is a framework used for evaluating the business’s Strengths, Weaknesses, Opportunities, and Threats. It can aid in identifying the problematic areas of your business so that you can maximize your opportunities. It will also alert you to the challenges your organization might face in the future.
In the 1970s, Bruce D. Henderson, founder of the Boston Consulting Group, came up with The Product Portfolio (aka BCG Matrix, or Growth-share Matrix), which would look at a successful businessproduct portfolio based on potential growth and market shares. It divided products into four main categories: cash cows, pets (dogs), question marks, and stars.
First proposed by accounting academic Robert Kaplan, the balanced scorecard is a management system that allows an organization to focus on big-picture strategic goals. The four perspectives of the balanced scorecard include financial, customer, business process, and organizational capacity. From there, according to the balanced scorecard, it’s possible to have a holistic view of the business.
A blue ocean is a strategy where the boundaries of existing markets are redefined, and new uncontested markets are created. At its core, there is valueinnovation, for which uncontested markets are created, where competition is made irrelevant. And the cost-value trade-off is broken. Thus, companies following a blue ocean strategy offer much more value at a lower cost for the end customers.
Businesses use scenario planning to make assumptions on future events and how their respective business environments may change in response to those future events. Therefore, scenario planning identifies specific uncertainties – or different realities and how they might affect future business operations. Scenario planning attempts at better strategic decision-making by avoiding two pitfalls: underprediction, and over-prediction.
Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
