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July 14 - September 12, 2020
Giving up the opportunity to sell something does not hurt as much as taking the money out of your wallet to pay for it. Opportunity costs are vague and abstract when compared to handing over actual cash.
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.
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.
The fact that people have diminishing sensitivity to both gains and losses has another implication. People will be risk-averse for gains, but risk-seeking for losses,
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!
As usual in these cases when demand has suddenly risen, a seller has to trade off short-term gain against possible long-term loss of good will, which can be hard to measure.
The distinguished economist and philosopher Amartya Sen famously called people who always give nothing in this game rational fools for blindly following only material self-interest: “The purely economic man is indeed close to being a social moron. Economic theory has been much preoccupied with this rational fool.”
a large proportion of people can be categorized as conditional cooperators, meaning that they are willing to cooperate if enough others do. People start out these games willing to give their fellow players the benefit of the doubt, but if cooperation rates are low, these conditional cooperators turn into free riders.
Economists need to adopt as nuanced a view of human nature as the farmers. Not everyone will free ride all the time, but some people are ready to pick your pocket if you are not careful. I keep a photograph of one of those farm stands in my office for inspiration.
paradigms change only once experts believe there are a large number of anomalies that are not explained by the current paradigm. A few scattered unexplained facts are not enough to upend the conventional wisdom.
“Discovery commences with the awareness of anomaly, i.e., with the recognition that nature has somehow violated the paradigm-induced expectations that govern normal science.” —Thomas Kuhn
First, people have a natural tendency to search for confirming rather than disconfirming evidence, as shown by the relative popularity of the 2 over the 3. This tendency is called the confirmation bias. Second, the confirmation bias can be accentuated when unwarranted assumptions make some kinds of disconfirming evidence seem unlikely, as illustrated by the unpopularity of turning over the B.
employment contracts could be viewed partially as a gift exchange. The theory is that if the employer treats the worker well, in terms of pay and working conditions, that gift will be reciprocated with higher effort levels and lower turnover, thus making the payment of above-market wages economically profitable.
In many companies, creating a large gain will lead to modest rewards, while creating an equal-sized loss will get you fired. Under those terms, even a manager who starts out risk neutral, willing to take any bet that will make money on average, will become highly risk averse. Rather than solving a problem, the organizational structure is making things worse.
Samuelson offered Brown a bet. Flip a coin, heads you win $200, tails you lose $100. As Samuelson had anticipated, Brown declined this bet, saying: “I won’t bet because I would feel the $100 loss more than the $200 gain.” In other words, Brown was saying: “I am loss averse.” But then Brown said something that surprised Samuelson. He said that he did not like one bet, but would be happy to take 100 such bets.
These experiments demonstrate that looking at the returns on your portfolio more often can make you less willing to take risk.
Most economists hypothesized—and it was a good starting hypothesis—that even if some people made mistakes with their money, a few smart people could trade against them and “correct” prices—so there would be no effect on market prices. The efficient market hypothesis,
Interestingly, Keynes thought markets were more “efficient,” to use the modern word, in an earlier period at the beginning of the twentieth century when managers owned most of the shares in a company and knew what the company was worth. He believed that as shares became more widely dispersed, “the element of real knowledge in the valuation of investments by those who own them or contemplate purchasing them … seriously declined.”
Keynes was also skeptical that professional money managers would serve the role of the “smart money” that EMH defenders rely upon to keep markets efficient. Rather, he thought that the pros were more likely to ride a wave of irrational exuberance than to fight it. One reason is that it is risky to be a contrarian. “Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.” Instead, Keynes thought that professional money managers were playing an intricate guessing game. He likened picking the best stocks to a common competition in the
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Professional investment may be likened to those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole: so that each competitor has to pick, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view. It is not a case of choosing those which, to the best of one’s
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In a rational world there would not be very much trading—in fact, hardly any. Economists sometimes call this the Groucho Marx theorem. Groucho famously said that he would never want to belong to any club that would have him as a member.
There is an old joke that says a Chicago economist would not bother to pick up a twenty-dollar bill on the sidewalk because if it were real, someone would already have snagged it. There is no such thing as a free lunch or a free twenty-dollar bill. But to a heretic like me, that twenty looked real enough to be worth bending over.
By this point I had adopted the pedagogical device of calling these essential elements “the three bounds”: bounded rationality, bounded willpower, and bounded self-interest.
The Coase theorem is named for its inventor, Ronald Coase, who had been a faculty member at University of Chicago Law School for many years. The theorem can be easily stated: in the absence of transaction costs, meaning that people can easily trade with one another, resources will flow to their highest-valued use.
costs are low, then what the judge decides won’t actually determine what economic activities will take place; the judge will just decide who has to pay. The article that includes this result, entitled “The Problem of Social Cost,” is one of the most cited economics articles of all time.
But the Coase theorem is not meant to be limited to tokens for which people are told their personal values.
In other words, the Coase theorem worked in theory, when trading for tokens redeemable for cash, but it did not work in practice, when trading for real-world objects like coffee mugs.
When people are given what they consider to be unfair offers, they can get angry enough to punish the other party, even at some cost to themselves.
If there is a number, people will use it.
The winner’s curse. When many bidders compete for the same object, the winner of the auction is often the bidder who most overvalues the object being sold.
The false consensus effect. Put basically, people tend to think that other people share their preferences.
This binding budget constraint means that the only way to build a winning team is to find players that provide more value than they cost.
This is the famous Peter Principle: people keep getting promoted until they reach their level of incompetence.
One way to salvage the Becker conjecture is to argue that CEOs, coaches, and other managers who are hired because they have a broad range of skills, which may not include analytical reasoning, could simply hire geeks who would deserve to be members of Becker’s 10% to crunch the numbers for them. But my hunch is that as the importance of a decision grows, the tendency to rely on quantitative analyses done by others tends to shrink. When the championship or the future of the company is on the line, managers tend to rely on their gut instincts.
Economists are really good at inventing rational explanations for behavior, no matter how dumb that behavior appears to be.
(Recall that the house money effect, introduced in chapter 10, says that people are more willing to take chances when they think they are ahead in the game.)
My coauthors and I have a conjecture for why this happens that we call the “big peanuts” hypothesis. The idea is that a certain amount of money can seem small or large depending on the context.
This reflects a general tendency. People are more willing to lie by omission than commission. If I am selling you a used car, I do not feel obligated to mention that the car is burning a lot of oil, but if you ask me explicitly: “Does this car burn a lot of oil?” you are likely to wangle an admission from me that yes, there has been a small problem along those lines. To get at the truth, it helps to ask specific questions.
At first blush, it would seem that increasing the returns to saving by creating tax-free accounts should increase saving, since the rewards for saving have gone up. But upon further reflection, one can see that the higher rates of return mean that it takes less saving to achieve a given retirement savings goal. Someone who is trying to accumulate a specific nest egg can achieve that goal with less saving if rates of return go up.
The special account may facilitate saving in two ways. First, the penalty for withdrawal acts as an inducement to leave the money invested. Second, a mental account that is designated as “retirement saving” is less tempting to dip into than a simple savings account.
The evidence suggests that when people get a windfall—and this seems to be the way people think about their tax refund, despite it being expected—they tend to save a larger proportion from it than they do from regular income, especially if the windfall is sizable.
key lesson we learned, which confirmed a strongly held suspicion, was that participation rates depended strongly on the ease with which employees could learn about the program and sign up.
“A regulation is asymmetrically paternalistic if it creates large benefits for those who make errors, while imposing little or no harm on those who are fully rational.”
John Tierney, a columnist for the New York Times, had a suggestion to encourage people to leave for higher ground before a storm strikes. Tierney’s idea was to offer those who opt to stay a permanent ink marker and suggest they use it to write their Social Security number on their body, to aid in the identification of victims after the storm.
you want people to comply with some norm or rule, it is a good strategy to inform them (if true) that most other people comply.
First, the program designers have a good reason to believe that a portion of the population will benefit by making some change in their behavior. In this case, with many people saving little or nothing for retirement, that was an easy call. Second, the target population must agree that a change is desirable. Here, surveys indicated that a majority of employees thought they should be saving more. Third, it is possible to make the change with one nearly costless action (or in the case of automatic enrollment, no action at all). I call such policies “one-click” interventions. Simply by ticking a
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Those looking for behavioral interventions that have a high probability of working should seek out other environments in which a one-time action can accomplish the job. If no one-time solution yet exists, invent one!
For example, one intriguing finding by Roland Fryer suggests that rewarding students for inputs (such as doing their homework) rather than outputs (such as their grades) is effective.
The team of Fryer, John List, Steven Levitt, and Sally Sadoff has found that the framing of a bonus to teachers makes a big difference. Teachers who are given a bonus at the beginning of the school year that must be returned if they fail to meet some target improve the performance of their students significantly more than teachers who are offered an end-of-year bonus contingent on meeting the same goals.*
