Michael's Reviews > Misbehaving: The Making of Behavioral Economics

Misbehaving by Richard H. Thaler
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bookshelves: neuroscience-psych

Misbehaving is a quickie intellectual history of behavioral economics, told by one of its founders, Richard Thaler. He’s a gleeful contrarian: loves economics, but loathes classical economic models and their assumptions of rationality. His career has been devoted to producing both lab-based and empirical studies documenting the irrationality of what he calls Humans (as opposed to Econs).

As an intro to his work, he describes his early years teaching undergraduate economics, and his students’ frustrations with his too-hard midterms and finals. Even after explaining that he graded on a strict curve, thus a 67% was not a failing grade when it was around the median, students remained upset. So he made the midterm and final out of 137 points, and like magic his students were happy, although their percentage correct was the same, as was the grade distribution. Having a score around 100 made students happy. This is an example of what he calls the influence of supposedly irrelevant factors (SIF’s): things that shouldn’t matter (to Econ’s), making a big difference in practice.

Some other tidbits I particularly enjoyed:
He characterizes objections by traditionalists as mainly forming two contradictory arguments, one the “learning” argument, the other the “incentives” argument. The former posits, in response to a paper showing irrational behavior in one-off decisions, such as buying a house or saving for retirement, that such behavior would change if only people were repeat players. Then, when a paper shows irrational behavior in frequent transactions, such as grocery store purchases, other traditionalists discount the findings because the stakes are too small: such behavior would change if the incentives were higher. As Thaler frames it, the rationality view becomes a theory that’s not falsifiable.

This isn’t just an academic debate: how economists and their models predict people will react to government actions (e.g., monetary policy, tax cuts, increased government spending) shapes which policies we enact. It’s important to empirically test the assumptions upon which these models are based, and adjust them accordingly.

Prospect theory, based on the endowment effect (basically, getting used to whatever you have) and resulting loss-aversion, making people on average experience twice as much disutility from losses as utility from corresponding gains.

The importance of fairness to humans, which explains seemingly irrational behavior (e.g., punishing people who are selfish, even at a cost to oneself). A related concept is what Thaler calls “transaction utility” in contrast to “acquisition utility,” the latter of which is the only thing an Econ would care about (am I getting more utility from whatever I’m buying than I would from the money I’m spending?); the former is the perceived fairness of the price: it’s why people can be tricked into buying several of something that they wouldn’t even buy one of, if the items are sufficiently discounted (90% off? Might as well!).

He reframes a widely-used economic (and legal) concept: that of the principal/agent problem. In discussing misalignment of incentives, he refers to it as the “dumb principal” problem: instead of blaming the e.g. risk-averse middle managers, his phrase puts the burden on the e.g. CEO to ensure a properly ex-ante analysis of risky decisions, e.g., new products/experimenting with different ways of doing things.

This is a short, fun book to read: it’s the tale of a changing of the guard in economics, told by one of the leaders of the winning side.
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June 22, 2015 – Finished Reading
June 28, 2015 – Shelved

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