Misbehaving: The Making of Behavioral Economics

by Richard H. Thaler

people valued things that were already part of their endowment more highly than things that could be part of their endowment, that were available but not yet owned.

Endowment effect

Humans have limited time and brainpower. As a result, they use simple rules of thumb—heuristics—to help them make judgments.

Heuristic

Economic theory at that time, and for most economists today, uses one theory to serve both normative and descriptive purposes.

One theory

Prospect theory sought to break from the traditional idea that a single theory of human behavior can be both normative and descriptive.

Prospect theory

people’s happiness—or utility, as economists like to call it—increases as they get wealthier, but at a decreasing rate. This principle is called diminishing sensitivity.

Diminishing sensitivity

diminishing sensitivity

Gaining $100 feels less than losing $100 if you are rich

People will be risk-averse for gains, but risk-seeking for losses,

Gains and losses

The fact that a loss hurts more than an equivalent gain gives pleasure is called loss aversion.

Loss aversion

So, we experience life in terms of changes, we feel diminishing sensitivity to both gains and losses, and losses sting more than equivalently-sized gains feel good.

Summary

Psychologists tell us that in order to learn from experience, two ingredients are necessary: frequent practice and immediate feedback.

Learning

The basic idea is that consumption is worth more to you now than later.

Consumption

The only way you can ever take 100 attractive bets is by first taking the first one, and it is only thinking about the bet in isolation that fools you into turning it down.

Myopic loss aversion