Behavioral Economics: The Stupid Things We Do

What is more important to you: money or security? Richard Thaler devoted his dissertation to this problem, which he called “The Cost of Living”. In one study, he asked a group of students two questions:

1. “How much are you willing to pay for a dose of antidote if there is a risk of contracting a deadly disease? The chance of infection is 1 in 1000.”

2. “How much would you agree to participate in research on the same disease? The chance of infection is 1 in 1000.”

If the students thought rationally, the sums in the answers would be the same. But the results showed that most were willing to pay $2000 for the antidote and would refuse to participate in the study if the compensation was less than $550.

Neither economic theory nor logic could explain such a difference in numbers. This was done by Richard Thaler, a “certified bummer,” a man who, at the time of graduation, was said to be: “We didn’t have much hope for him,” and also the winner of the Nobel Prize in Economics in 2017. He noticed that people make many bad decisions, but the main thing is that our mistakes can be predicted.

1. We feel the loss more than the joy of equal gain.

In theory, before making a decision, we should ask ourselves about the “cost of opportunity”: what will I lose if I do this? But that’s a theory: To show what’s really going on, Thaler cited the example of Richard Rosette, a wine collector who kept $100 worth of bottles in his cellar.

He did not like wine, but he did not want to sell it, and he did not buy another wine for the same 100 dollars. According to his logic, leaving everything as it is (tasteless expensive wine in the cellar) means not losing anything, while buying new tasty wine means re-laying $ 100 out of your wallet (even if you got it from selling old wine).

2. We enjoy or get upset based on the terms of the purchase, not the usefulness of the product.

We will happily eat a hot dog during a sports game, although it will cost more than in a tent on the street. In a bar, we are willing to pay more for soft drinks than in a store near the house. And if we see goods at a very attractive price, we can buy even if they are not needed. We do this simply because we like the buying situation itself: the combination of time, place, circumstances, and our own high spirits.

3. It’s hard for us to give up something if we have already given money or invested effort.

Did you have to go to work when you were sick, or go to a concert in spite of a heavy snowstorm so that your tickets would not be lost? Mythical characters from economics textbooks do not do this: if the costs cannot be recovered, then it is not worth thinking about them, they say. We are giving them great attention. In addition, the more we pay, the longer we are willing to endure discomfort. Remember, for example, how you tried to break in expensive shoes.

But over time, the willingness to make sacrifices to avoid loss weakens. This is how another phenomenon manifests itself – “depreciation of payment.”

4. When planning a budget, we adhere to strict rules, even when it is not necessary

Speaking of the budget, Thaler recalls how important it is to spend money in accordance with one’s own needs, and not following prescriptions and rules. Sometimes the strict allocation of the family budget can lead to wrong decisions. In 2007, US fuel prices fell by about 50%, and most families, instead of spending the money they saved on groceries or buying appliances, started filling their car with higher-grade gasoline.

5. Sometimes we find it hard to control ourselves (“cashew nuts”)

Once Thaler invited friends to dinner. While the guests were waiting for the main dish to bake, the host brought a large bowl of cashews. In five minutes, friends ate half of the nuts so that they would not interrupt their appetite, Thaler had to carry the vase back to the kitchen, and the guests were grateful to him.

The rational man in the economics textbook will act according to his preferences: if he wants to eat nuts, he will leave them on the table, otherwise he will remove them. But the guests of Thaler, despite their desire, understood that they could not resist and kill their appetite, so they were glad when he hid the cashews.

We are guided by the same motives when we put an alarm clock in the far corner of the room, artificially set deadlines for ourselves, or buy sweets by the piece, although the packaging would cost us less. Often, our choice does not reveal preferences, as economists believe, but simply helps to control ourselves.

6. We do not want to risk what we have, even if we got it by accident.

Researchers Jack Knetsch and John Sinden discovered another curious feature of our behavior. They conducted an experiment: half of the participants were given three dollars, the rest were given a lottery ticket, which made it possible to win a valuable prize. After that, they were asked the question: “Would you rather have three dollars or a lottery ticket?”

According to the textbooks, what we get initially should not have influenced our choice. But most of those who had a lottery ticket from the beginning decided to keep it, and only a third of those who got the money were willing to buy it.

7. “Narrow framing”: we do not consider the chain of events as a whole

You can look at any problem from the inside, narrowly, or from the outside. With a correct assessment of the situation, the second option will be more reliable. True, at the moment of making a decision, we do not think about it.

An example demonstrating such behavior was suggested to Thaler by his friend Dani. Together with a team of researchers, he was involved in the development of curricula for high school students. After a few months, Dani had a question about how long it would take to complete the project. He interviewed several colleagues and received responses ranging from 18 to 30 months. But among the team members was an expert on the development of such programs, and Dani asked him to evaluate, based on his experience. The expert, who had previously quoted a time limit of 30 months, now said that such work used to take at least seven years and in half of the cases it was never completed.

The view from the inside limited the expert, so he chose an optimistic forecast, and the look from the outside allowed him to give a more accurate estimate.

8. We strive to avoid what we think is an “unfair” offer, even if we ourselves suffer in doing so.

Thaler first discovered this pattern when he argued with a neighbor over a willow tree: it grew near the border of two plots, closer to Thaler’s house, and cleaning its foliage was a lot of trouble. Thaler liked the tree, but a neighbor asked him to destroy it.

To save the relationship, Thaler found out how much it costs to cut down a willow (it turned out: his monthly salary). After that, the professor came to the neighbor and said that the tree did not bother him personally, but he would not mind if the neighbor removed it from the site at his own expense. The neighbor considered this proposal unfair, slammed the door, and they did not return to this issue again.

9. We don’t always know what we like (“inverted preference phenomenon”)

We like to think that we have well-defined preferences, but we don’t. Thaler describes an experiment in which subjects choose between two gambling games: a lottery with a guaranteed prize of $10 (B) and a gamble with a low probability of winning $30 (A). The majority of survey participants chose the win-win lottery (B). But when asked how much they were willing to sell each game for, most people rated option A higher than option B.

10. “Big nuts”: the amount may seem large or small to us depending on the context

Many of us are willing to drive across town to save $10 on a Walkman, but are not willing to do the same to buy a TV. The fact is that $10 in the context of buying a TV seems like a “nut” or a discount not significant enough to make an effort.

In general, you and I are irrational creatures, and, knowing this, many manufacturers profit from us. But is it really that scary? “Except in rare cases, the inability to act in accordance with the model of rational behavior is not fatal,” says Richard Thaler. However, forewarned is forearmed: knowing about our features, we can change a lot in our consumer behavior.

About the author: Richard Thaler is an American economist, recipient of the 2017 Nobel Prize in Economics for his contributions to the field of behavioral economics, and Distinguished Professor of Behavioral Science and Economics at the University of Chicago Business School.