The Psychologist Who Transformed Economic Thinking

"I will never know if my vocation as a psychologist was a result of my early exposure to interesting gossip, or whether my interest in gossip was an indication of a budding vocation," wrote Daniel Kahneman in the biographical sketch he published upon receiving the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel in 2002. "Like many other Jews, I suppose, I grew up in a world that consisted exclusively of people and words, and most of the words were about people. Nature barely existed, and I never learned to identify flowers or to appreciate animals. But the people my mother liked to talk about with her friends and with my father were fascinating in their complexity. Some people were better than others, but the best were far from perfect and no one was simply bad. Most of her stories were touched by irony, and they all had two sides or more."

"I grew up in a world that consisted exclusively of people and words, and most of the words were about people." Daniel Kahneman | Wikimedia, nrkbeta

People are Complex

Daniel Kahneman was born in Tel Aviv on March 5, 1934, during a visit his mother made to relatives in what was then the Land of Israel. His parents, Lithuanian immigrants, had settled in Paris in the early 1920s, where they raised Daniel and his sister. The family integrated well into French society, and his father  led a research team at a chemical factory. When Daniel was six, the Nazis invaded France, and the family went into hiding. Jews were required to wear a yellow badge and to obey a 6 p.m. curfew. 

One day, while playing with a Christian friend, Daniel lost track of time. Afraid of being caught, he turned his sweater inside out to hide the yellow badge and rushed home through empty streets. Unfortunately, a German soldier spotted him. "He was wearing the black uniform that I had been told to fear more than others – the one worn by specially recruited SS soldiers," he recalled. "As I came closer to him, trying to walk fast, I noticed that he was looking at me intently. Then he beckoned me over, picked me up, and hugged me. I was terrified that he would notice the star inside my sweater. He was speaking to me with great emotion, in German. When he put me down, he opened his wallet, showed me a picture of a boy, and gave me some money. I went home more certain than ever that my mother was right: people were endlessly complicated and interesting."

Later in the war, Kahneman’s father was arrested and imprisoned at the Drancy internment camp, a transit camp for Jews awaiting deportation to extermination camps. He was released six weeks later, thanks to the intervention of the manager of the factory at which he worked. The family fled Nazi-occupied Paris to the Vichy-controlled Free Zone, but after that too was taken over by the Nazis, they were forced to flee again and live in hiding. His father, who had diabetes, was unable to receive proper treatment during the war and died in 1944—just weeks before the Allied invasion of France.

"I went home more certain than ever that my mother was right: people were endlessly complicated and interesting." Kahneman at the World Economic Forum, 2013 | flickr, World Economic Forum

Early Illusions

In 1946, the rest of the family immigrated to the Land of Israel and settled in Jerusalem. Kahneman attended the high school affiliated with the Hebrew University and was active in the Scouts youth movement. He was torn between studying philosophy—a subject that had fascinated him since childhood—and psychology, and ultimately chose the latter. “I was discovering that I was more interested in what made people believe in God than I was in whether God existed, and I was more curious about the origins of people’s peculiar convictions about right and wrong than I was about ethics,” he said. He went on to pursue a Bachelor’s degree in psychology and mathematics at the Hebrew University as part of the academic reserve program, and in 1954 he was drafted into the IDF as an officer.

After serving as a platoon commander in a field unit, he was transferred to the military psychology unit. There, he worked on screening candidates for service, developed the personal interview process at the recruitment office, and helped design the "KABA" (quality group) tests used to assess military suitability. He also evaluated candidates for officer training. Two psychologists would observe how candidates handled a challenging group task, trying to infer who possessed leadership qualities, who was loyal to the leader, who was merely boastful without substance, and so on. Once a month, the psychologists met with officer school staff to receive feedback on their evaluations. “The story was always the same: our ability to predict performance at the school was negligible,” Kahneman wrote. “I was so impressed by the complete lack of connection between the statistical information and the compelling experience of insight that I coined a term for it: “the illusion of validity.”   Almost twenty years later, this term made it into the technical literature. It was the first cognitive illusion I discovered.”

Two psychologists would observe candidates facing a difficult group challenge and infer who had leadership qualities, who was loyal to the leader, and more. However, their ability to accurately assess the candidates’ personalities was “negligible.” People facing a group challenge | Shutterstock, David Gyung

The Beginning of a Remarkable Partnership

After his discharge from the IDF in 1956, Daniel Kahneman received a scholarship from the Hebrew University to pursue doctoral studies abroad and enrolled at the University of California, Berkeley.

His dissertation focused on the statistical analysis of relationships between values in semantic differential questionnaires, where individuals rate people, products, or organizations on scales between opposing adjectives—such as positive vs. negative or honest vs. corrupt. Kahneman later said the project allowed him to combine two of his professional passions: programming and statistical correlations and that he completed the dissertation in merely eight days. Still, this was only a small part of his time in the United States, where he explored a wide range of professional areas—from studying neural mechanisms of vision to working in a psychoanalytic clinic. 

In 1961, he returned to Israel and joined the psychology department at the Hebrew University as a researcher. His early work focused on bringing psychological research into real-life contexts. He collaborated with agricultural advisors working with immigrants from developing countries, and with instructors at the Israeli Air Force flight school.

In 1968, after years of working across multiple domains, Kahneman began collaborating with a fellow young researcher who had recently joined the university after earning his PhD in the United States: Amos Tversky, a colleague Kahneman had known since their undergraduate years. The two shared a keen interest in statistical questions—especially in how people perceive and interpret statistical information—and soon began conducting joint research.

The two shared a fascination with statistical questions, particularly how people perceive statistical concepts. Kahneman (right) and Tversky in the 1970s | Source: Barbara Tversky

Irrational Behavior

Kahneman and Tversky’s first joint research focused on heuristics—mental shortcuts or rules of thumb that allow us to make decisions or reach conclusions quickly. In a groundbreaking study published in 1974 in the journal Science, they demonstrated that such heuristics can mislead us and result in errors in judgement.

One example from their study presented participants with the following scenario: “Consider an individual who has been described by a former neighbor as follows: Steve is very shy and withdrawn, invariably helpful, but with little interest in people, or in the world of reality. A meek and tidy soul, he has a need for order and structure and a passion for detail.” The participants were then asked to decide which was more likely to be Steve’s occupation : librarian or farmer?

Most respondents chose “librarian,” relying on the representativeness heuristic—judging likelihood on how closely the description fits a stereotype. However, they overlooked an important statistical reality: there are far more farmers than librarians in the U.S. population. Statistically, Steve is more likely to be a farmer, despite fitting the librarian stereotype.

This was their first publication in a long series of studies that fundamentally changed the prevailing assumption that people make sound, intuitive decisions. Kahneman and Tversky revealed that what appears to be rational judgment is often riddled with systematic errors and cognitive biases.

 In many cases, seemingly rational judgment is riddled with errors and cognitive biases. Illustration of a choice between logic and intuition | Shutterstock, Pixelvario

In the years that followed, their research also delved  into the realm of economic decision-making. Participants were presented with scenarios such as: “Would you prefer to receive 3,000 dollars right now, or take a gamble with an 80% chance of receiving 4,000 dollars—and a 20% chance of getting nothing?” And its loss-framed counterpart: “You might lose 3,000 dollars, or you can take a gamble—an 80% chance of losing 4,000 dollars, but a 20% chance of losing nothing.”

Mathematically, there isn’t a large difference between the options, but most people prefer to take the guaranteed 3,000 dollars rather than gamble for a potentially higher amount. Conversely, when faced with losses, most respondents preferred to gamble, risking an even greater loss, rather than accepting an immediate loss of 3,000 dollars.

Kahneman and Tversky demonstrated that even in economics, our decision-making is not rational - we perceive gains and losses differently. People are risk-averse when it comes to gains but risk-seeking when it comes to losses. They also demonstrated that we attribute greater value to objects simply because we own them, and that we evaluate price differences differently depending on the ratio between the difference and the overall price. For instance, the difference between five dollars and eight dollars seems substantial to us, while the difference between 505 dollars and 508 dollars feels negligible—even though both differences are exactly three dollars. These findings formed the basis of Prospect Theory, which they published in a landmark paper in 1979.

Prospect Theory brought about a real revolution in economics. Until then, economic models were based on the assumption of “rational actors”—meaning individuals were expected to make consistently logical decisions aimed at maximizing personal gain - from everyday purchases to stock market investments. Kahneman and Tversky demonstrated that this assumption was flawed, showing that numerous factors—often subtle or difficult to predict—significantly influence our decision-making. These findings had a major impact not only on theory, but also influenced economic policies of financial institutions and governments.

Kahneman and Tversky showed that even in economics, our decision-making is not purely rational—we perceive gains and losses differently. Illustration of a decision made by the brain or the heart | Shutterstock, Golden Dayz

A Partnership in Crisis

During that decade of working together, Kahneman and Tversky spent many hours each day side by side. “We got to know each other’s mind almost as well as our own. We could (and often did) finish each other’s sentences and complete the joke that the other had wanted to tell.” Kahneman said. He added that by conscious decision,  they avoided assigning fixed roles: both would contribute ideas for research, develop and refine them together, so that the ideas belonged to both of them. The decision of whose name would appear first on a paper was left to a coin toss.

The collaborative harmony began to fracture in the late 1970s. Kahneman divorced his first wife, Irah, a social sciences researcher and the mother of his two children, and in 1978 married British cognitive psychologist Anne Treisman. The couple moved to Vancouver, Canada, where both accepted research positions. Around the same time, Tversky also left Israel and—much to Kahneman's disappointment—accepted a position at the more prestigious Stanford University in California. Their collaboration continued, but with less intensity. Nevertheless, In 1981 they published one of their most significant joint papers —on decision framing and the psychology of choice. The following year saw the release of their edited volume Judgment under Uncertainty: Heuristics and Biases.

In 1984, Tversky received a prestigious MacArthur Fellowship independently of Kahneman, which likely deepened the rift between them. That same year, Kahneman accepted a position at the University of California, Berkeley. The two made occasional efforts to revive their collaboration, with limited success. In 1993, Kahneman moved to Princeton University on the East Coast. Attempts to rekindle their collaboration were cut short by Tversky’s death from cancer in 1996, at the age of just 59.

In addition to his academic work, he published three books presenting his research to the general public: Rationality, Fairness, Happiness (2005), Thinking, Fast and Slow (2013), and Noise (2022). His book Thinking, Fast and Slow | Shutterstock, hamdi bendali

Observing Human Nature

In 2002, Daniel Kahneman was awarded the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, along with Vernon Smith, another pioneer in behavioral economics. Although the prize recognized Kahneman’s joint work with Tversky, Nobel Prizes are not awarded posthumously. “We were a team, and we remained in that mode for well over a decade. The Nobel Prize was awarded for work that we produced during that period of intense collaboration,” Kahneman said in his Nobel lecture.

Kahneman continued to conduct research throughout his life, both before and after receiving the prestigious award. His work focused not only on economic behavior, but also on psychological factors that influence happiness and life satisfaction—dimensions that, in turn, also affect economic decision-making.  In addition to his academic contributions, he authored three books based on his research, written for a general audience: Rationality, Fairness, Happiness (2005), Thinking, Fast and Slow (2013), and Noise (2022).

In addition to the Nobel Prize in Economics, Kahneman received numerous other honors, including the Presidential Medal of Freedom, awarded by U.S. President Barack Obama in 2013, and dozens of honorary doctorates from universities around the world. His wife, Anne Treisman, passed away in 2018, and in recent years Kahneman lived in New York with Barbara Tversky, the widow of his longtime partner Amos. He passed away just weeks after his 90th birthday. 

In addition to the Nobel Prize in Economics, he received numerous honors, including the Presidential Medal of Freedom, presented to him by U.S. President Barack Obama in 2013 | Shutterstock, Rena Schild

Kahneman, who transformed our understanding of economic behavior, often remarked with a smile that he had never taken a single course in economics. His deep curiosity about people—perhaps shaped by his mother’s gossip and his experiences during the Holocaust—ultimately led him to revolutionize how we think about ourselves and our behavior. In an interview on The New York Times podcast in 2021, he said that if he were starting his career today, he would choose between studying neuroscience or specializing in artificial intelligence: “These are two especially exciting ways to observe human nature.”