Misbehaving: The Making of Behavioral Economics

by Richard H. Thaler

I made the total number of points available 137 instead of 100. This exam turned out to be slightly harder than the first, with students getting only 70% of the answers right, but the average numerical score was a cheery 96 points.

economists carry the most sway when it comes to influencing public policy. In fact, they hold a virtual monopoly on giving policy advice.

To an Econ, the price paid for some food item in the past is not relevant in making the decision about how much of it to eat now. An Econ would also not expect a gift on the day of the year in which she happened to get married, or be born.

I don’t advise giving cash on your next anniversary. Come to think of it, even if your spouse is an economist, this is probably not a great idea.

Econs do not have passions; they are cold-blooded optimizers.

Two research tools that have emerged over the past twenty-five years have greatly expanded economists’ repertoire for learning about the world. The first is the use of randomized control trial experiments, long used in other scientific fields such as medicine. The typical study investigates what happens when some people receive some “treatment” of interest.

The second approach is to use either naturally occurring experiments (such as when some people are enrolled in a program and others are not) or clever econometrics techniques that manage to detect the impact of treatments even though no one deliberately designed the situation for that purpose.

Economists get in trouble when they make a highly specific prediction that depends explicitly on everyone being economically sophisticated.

Behavioral economics is more interesting and more fun than regular economics. It is the un-dismal science.

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In 2010 the government of the United Kingdom formed a Behavioural Insights Team,

This book is the story of how this happened, at least as I have seen it. Although I did not do all the research—as you know, I am too lazy for that—I was around at the beginning and have been part of the movement that created this field.

a series of topics that occupied most of my attention for the first fifteen years of my research career: mental accounting, self-control, fairness, and finance.

My objective is to explain what my colleagues and I learned along the way, so that you can use those insights yourself to improve your understanding of your fellow Humans.

two ways to ask the question: either in terms of “willingness to pay” or “willingness to accept.” The first asks how much you would pay to reduce your probability of dying next year by some amount, say by one chance in a thousand. The second asks how much cash you would demand to increase the risk of dying by the same amount. To put these numbers in some context, a fifty-year-old resident of the United States faces a roughly 4-in-1,000 risk of dying each year.

A. Suppose by attending this lecture you have exposed yourself to a rare fatal disease. If you contract the disease you will die a quick and painless death sometime next week. The chance you will get the disease is 1 in 1,000. We have a single dose of an antidote for this disease that we will sell to the highest bidder. If you take this antidote the risk of dying from the disease goes to zero. What is the most you would be willing to pay for this antidote? (If you are short on cash we will lend you the money to pay for the antidote at a zero rate of interest with thirty years to pay it back.) B. Researchers at the university hospital are doing some research on that same rare disease. They need volunteers who would be willing to simply walk into a room for five minutes and expose themselves to the same 1 in 1,000 risk of getting the disease and dying a quick and painless death in the next week. No antidote will be available. What is the least amount of money you would demand to participate in this research study?

but one clear pattern emerged: the answers to the two questions were not even close to being the same. Typical answers ran along these lines: I would not pay more than $2,000 in version A but would not accept less than $500,000 in version B. In fact, in version B many respondents claimed that they would not participate in the study at any price.

He told me that he had bottles in his cellar that he had purchased long ago for $10 that were now worth over $100. In fact, a local wine merchant named Woody was willing to buy some of Rosett’s older bottles at current prices. Rosett said he occasionally drank one of those bottles on a special occasion, but would never dream of paying $100 to acquire one.

why wouldn’t he also be willing to buy such a bottle? In fact, why did he refuse to buy any bottle that cost anything close to $100? As an economist, Rosett knew such behavior was not rational, but he couldn’t help himself.

I called this phenomenon the “endowment effect” because, in economists’ lingo, the stuff you own is part of your endowment, and I had stumbled upon a finding that suggested 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.

The day of the game there is a big snowstorm. We decide not to go, but Jeffrey remarks that, had we bought the (expensive) tickets, we would have braved the blizzard and attempted to drive to the game.

Linnea is shopping for a clock radio. She finds a model she likes at what her research has suggested is a good price, $45. As she is about to buy it, the clerk at the store mentions that the same radio is on sale for $35 at new branch of the store, ten minutes away, that is holding a grand opening sale. Does she drive to the other store to make the purchase? On a separate shopping trip, Linnea is shopping for a television set and finds one at the good price of $495. Again the clerk informs her that the same model is on sale at another store ten minutes away for $485. Same question . . . but likely different answer.

Some friends come over for dinner. We are having drinks and waiting for something roasting in the oven to be finished so we can sit down to eat. I bring out a large bowl of cashew nuts for us to nibble on. We eat half the bowl in five minutes, and our appetite is in danger. I remove the bowl and hide it in the kitchen. Everyone is happy.

a behavior that is inconsistent with economic theory.

“ignore sunk costs,” meaning money that has already been spent. The price we paid for the tickets should not affect our choice about whether to go to the game.

If Linnea spends ten minutes to save $10 on a small purchase but not a large one, she is not...

started with the duo’s summary paper published in Science: “Judgment Under Uncertainty: Heuristics and Biases.” At the time I was not sure what a heuristic was, but it turns out to be a fancy word for a rule of thumb.

For example, a firm should set prices so that marginal cost equals marginal revenue. When economists use the term “marginal” it just means incremental, so this rule implies that the firm will keep producing until the point where the cost of the last item made is exactly equal to the incremental revenue brought in.

I offer you a choice between an additional $1,000 for sure or a 50% chance to win $2,000, you will take the sure thing because you value the second thousand you would win less than the first thousand, so you are not willing to risk losing that first $1,000 prize in an attempt to get $2,000.

People think about life in terms of changes, not levels. They can be changes from the status quo or changes from what was expected, but whatever form they take, it is changes that make us happy or miserable. That was a big idea.

The difference between losing $10 and $20 feels much bigger than the difference between losing $1,300 and $1,310.

The Weber–Fechner Law holds that the just-noticeable difference in any variable is proportional to the magnitude of that variable. If I gain one ounce, I don’t notice it, but if I am buying fresh herbs, the difference between 2 ounces and 3 ounces is obvious.

Psychologists refer to a just noticeable difference as a JND. If you want to impress an academic psychologist, add that term to your cocktail party banter. (“I went for the more expensive sound system in the new car I bought because the increase in price was not a JND.”)

being more willing to drive ten minutes to save $10 on a $45 clock radio than on a $495 television set. For the latter purchase, the savings would not be a JND.

Roughly speaking, losses hurt about twice as much as gains make you feel good.

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.

suggestion that only economists behave like Econs.

Most academics find getting the initial ideas the most enjoyable part of research, and conducting the actual research is almost as much fun. But few enjoy the writing, and it shows.

To this day, the phrase “survey evidence” is rarely heard in economics circles without the necessary adjective “mere,” which rhymes with “sneer.” This disdain is simply unscientific.

Apparently economists don’t mind survey data as long as someone other than the researcher collected it.

Real life is not as controlled

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

Suppose you pay attention to sunk costs, and finish a rich dessert after a big dinner just because you paid for the dessert. What will happen to you? If you make this mistake often you might be a bit chubbier, but otherwise you are fine.

two papers. One expounded on the List, and the other was called “An Economic Theory of Self-Control.

a new journal called the Journal of Economic Behavior

what has now become known as mental accounting. The second was self-control and, more generally, choosing between now and later.

Losses hurt about twice as much as gains make us feel good. This raises the question: if you pay $5 for a sandwich, do you feel like you just lost $5? For routine transactions, the answer is clearly no. For one thing, thinking that way would make you miserable. Because losses are weighed about twice as heavily as gains, even trading a ten-dollar bill for two fives would be viewed as a loss with this sort of accounting.

People are willing to pay more for the beer if it was purchased from the resort than from the convenience store.

These results show that people are willing to pay different prices for the same beer, consumed at the same spot on the beach, depending on where it was bought.

Why do the respondents care where the beer was bought? One reason is expectations. People expect prices to be higher at a fancy hotel, in part because the costs are quite obviously higher. Paying seven dollars for a beer at a resort is annoying but expected; paying that at a bodega is an outrage! This is the essence of transaction utility.

Everyone has items in their closets that are rarely worn but were “must buys” simply because the deal was too good, and of course somewhere in the garage or attic is our version of Maya’s quilt.