ABSTRACT
Given uncertainty in the world, people form beliefs over the multitude of possibilities before them. The standard economics approach assumes that such beliefs are “correct.” That is, people do not believe outcomes are more or less likely to occur than is true. And when introduced to new information, beliefs are not only revised, but are updated via Bayes’ rule. But if people, at the individual level or in aggregate, do not consistently hold such beliefs, then economic models can fail to describe reality. This chapter explores evidence for common beliefs that deviate from the standard assumption. It begins with evidence of overconfidence in judgements (e.g., overestimation, overplacement, overprecision, optimism). Two potential sources of overconfidence are discussed: the anchoring and adjustment heuristic, and confirmation bias. The chapter concludes with three well-documented errors in probabilistic reasoning: the gambler’s fallacy, extrapolative beliefs, and base-rate neglect. The representativeness heuristic and a belief in the law of small numbers provide explanations for such reasoning.
