Misbehaving: The Making of Behavioral Economics

by Richard H. Thaler

The core premise of economic theory is that people choose by optimizing.

Many years later Kahneman and Tversky would call this distinction “framing,” but marketers already had a gut instinct that framing mattered. Paying a surcharge is out-of-pocket, whereas not receiving a discount is a “mere” opportunity cost.

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 Weber–Fechner Law holds that the just-noticeable difference in any variable is proportional to the magnitude of that variable.

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

The fact that a loss hurts more than an equivalent gain gives pleasure is called loss aversion. It has become the single most powerful tool in the behavioral economist’s arsenal.

A good rule to remember is that people who are threatened with big losses and have a chance to break even will be unusually willing to take risks, even if they are normally quite risk averse. Watch out!

During the day several people described how the interest rate of 2.9% had been determined. Apparently Roger Smith, the CEO, had called a meeting to determine how they were going to deal with surplus inventory that year and someone had suggested a promotion based on lower interest rates.

As I have learned over the years, and will discuss further in subsequent chapters, the reluctance to experiment, test, evaluate, and learn that I experienced at General Motors is all too common.

People act the same way: they stick with what they have unless there is some good reason to switch, or perhaps despite there being a good reason to switch. Economists William Samuelson and Richard Zeckhauser have dubbed this behavior “status quo bias.”

Loss aversion and status quo bias will often work together as forces that inhibit change.

1. If you want to encourage someone to do something, make it easy. This is a lesson I learned from Danny Kahneman, based on the work of Kurt Lewin, a prominent psychologist of the first half of the twentieth century. Lewin described the first step in getting people to change their behavior as “unfreezing.” One way to unfreeze people is to remove barriers that are preventing them from changing, however subtle those barriers might be.

We can’t do evidence-based policy without evidence.

People become overconfident because they never bother to document their past track record of wrong predictions,

The only protection against overconfidence is to systematically collect data, especially data that can prove you wrong.

Many organizational errors could have been easily prevented if someone had been willing to tell the boss that something was going wrong.

Good leaders must create environments in which employees feel that making evidence-based decisions will always be rewarded, no matter what outcome occurs.

The ideal organizational environment encourages everyone to observe, collect data, and speak up.