Many people believe in the "Law of Small Numbers," exaggerating the degree to which a small sample resembles the population from which it is drawn. To model this, I assume that a person exaggerates the likelihood that a short sequence of i.i.d. signals resembles the long-run rate at which those signals are generated. Such a person believes in the "gambler's fallacy", thinking early draws of one signal increase the odds of next drawing other signals. When uncertain about the rate, the person over-infers from short sequences of signals, and is prone to think the rate is more extreme than it is. When the person makes inferences about the frequency at which rates are generated by different sources --- such as the distribution of talent among financial analysts --- based on few observations from each source, he tends to exaggerate how much variance there is in the rates. Hence, the model predicts that people may pay for financial advice from "experts" whose expertise is entirely ...

Psychological research indicates that people have a cognitive bias that leads them to misinterpret new information as supporting previously held hypotheses. We show in a simple model that such confirmatory bias induces overconfidence: given any probabilistic assessment by an agent that one of two hypotheses is true, the appropriate beliefs would deem it less likely to be true. Indeed, the hypothesis that the agent believes in may be more likely to be wrong than right. We also show that the agent may come to believe with near certainty in a false hypothesis despite receiving an infinite amount of information.

Departures from self-interest in economic experiments have recently inspired models of “social preferences”. We design a range of simple experimental games that test these theories more directly than existing experiments. Our experiments show that subjects are more concerned with increasing social welfare—sacrificing to increase the payoffs for all recipients, especially low-payoff recipients—than with reducing differences in payoffs (as supposed in recent models). Subjects are also motivated by reciprocity: They withdraw willingness to sacrifice to achieve a fair outcome when others are

People exaggerate the degree to which their future tastes will resemble their current tastes. We present evidence from a variety of domains which demonstrates the prevalence of such projection bias, develop a formal model of it, and use this model to demonstrate its importance in economic environments. We show that, when people exhibit habit formation, projection bias leads people to consume too much early in life, and to decide, as time passes, to consume more—and save less—than originally planned. Projection bias can also lead to misguided purchases of durable goods. We discuss a number of additional applications and implications.