• many picture frames

    One Reason We Think a High Price Looks Low

    Jan 22 • Behavioral Economics, Businesses, Demand, Supply, and Markets, Economic Thinkers, Households, Money and Monetary Policy • 627 Views

    The decisions we make about bread machines, surgery and gasoline can be remarkably similar.

    Where are we going? To the influence of a frame.

    But first…

    Bread Machines

    Maybe 20 years ago, when bread machines were first introduced, one retailer started with a single model priced at $120. Faced with sparse sales, they increased interest by adding a second $80 machine.

    What happens next though is what gets the behavioral economists really excited. The retailer placed a $475 machine on the shelf and the $120 model sold like hotcakes.

    Surgery

    In an experiment at Harvard by psychologist Amos Tversky, physicians were given one of two statements about the success of a surgical procedure. Asked if they should operate, the majority of respondents said yes to the first statement. Both though are the same:

    • The one-month survival rate is 90 percent.
    • There is a 10 percent mortality in the first month.

    and finally…

    Gasoline

    Asked if $3.00 a gallon gas makes you happy, you probably would say no. But why then, a year ago, would you have been pleased?  The following graph has the clue:

    Behavioral economics and gas price framing

    Frames

    For bread machines, surgery and gasoline, our attitudes are shaped by a reference point that behavioral economists call a frame. With the bread machines, the $425 machine signaled that $120 was a good price. For surgery, when the frame was a positive statement, the response was positive. For gasoline, the direction in which prices moved created the frame. Moving downward from $4.00, $3.00 looks good but not when price rises from $2.00.

    Our Bottom Line: Competition

    In traditional economic texts, price making power increases as you move across the following continuum:

    Frames give firms more pricing power

    To enhance their price making power, firms have been able to influence consumers with frames. Now though, with Amazon and the potential for other online price comparisons, I wonder if the power to frame has diminished or at least changed.

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  • everyday economic invisible hand and hot hand

    Can Economists See the Hot Hand?

    Jan 21 • Behavioral Economics, Demand, Supply, and Markets, Economic Debates, Economic History, Economic Thinkers, Financial Markets, Sports, Thinking Economically • 757 Views

    When basketball commentators used to say, “Larry Bird has the hot hand…,” the fans knew what they meant. Because Bird was sinking basket after basket, we could predict that he will do more of the same.

    Yes?

    No, according to behavioral economists.

    Where are we going? To see how the debate over whether the hot hand exists applies to more than sports. Let’s start with hot hand research.

    Rejecting the Hot Hand

    Using Philadelphia 76er shooting records (1980-81 season) from 48 home games and Boston Celtics free throws during the 1980s, believers in behavioral economics tried to prove that there was no such thing as a hot hand. Their focus was whether “a player’s chance of hitting a shot is greater following a hit than following a miss on the previous shot.”

    Responding to doubters, researchers agreed that their data was skewed by the intensified defense from the opposing teams but still affirmed their accuracy. To others who wondered how they could challenge the opinions of knowledgeable fans, players and commentators, researchers said it was a self-fulfilling prophecy. Confirmation bias even enters the picture because the belief preceded the phenomenon that proved it.

    The Hot Hand Shakes the Invisible Hand

    Now classical economists are fighting back. Using two million observations and 10 criteria for batters and pitchers including on base bats, home runs, strike outs, and walks, a finance professor from Stanford and an economist from Berkeley found evidence of the hot hand in baseball stats. They say the data has to come from baseball because basketball has too many strategic responses to the hot hand. But even for basketball, rather than random, the hits and misses are an equilibrium adjustment.

    Our Bottom Line: Debating Behavioral Economics

    For years, behavioral economists have told us that there is no such thing as a hot streak. Basing their conclusion on their belief that many of our actions are irrational, they conclude fans are falsely bringing order to random achievements that have no predictive value.

    The economists who disagree suggest that judging the extent of order in a situation, whether sports, finance, or elsewhere, should return us to Adam Smith’s invisible hand rather than random behavior. Reminding us that we need a proper diagnosis to formulate the right solution, they cite the significance of their disagreement.

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  • everyday economics, behavioral economics and saving less

    How Chocolate Chip Cookies Explain Why We Save Less

    Jan 20 • Behavioral Economics, Economic Thinkers, Government, Households, Labor, Lifestyle, Macroeconomic Measurement, Money and Monetary Policy • 688 Views

    Let’s start with two people and two plates of freshly baked chocolate chip cookies. The first person eats one and then, thinking she will enjoy some during the next week, wraps up the rest and places them in a cabinet. As for the second individual, he sees the other plate and gobbles them all.

    Where are we going? To decisions about saving and then back to cookies.

    Saving Worries

    According to Gallup’s annual Economy and Personal Finance Poll, not having enough money for retirement is a big worry for 59 percent of us.

    Behavior economics and retirement savings

    Perhaps one reason for our worry is inadequate saving. According to St. Louis Fed statistics (below), our personal saving rate–what we do not spend from our disposable income–has remained relatively low.

    Behavioral economics and personal saving rate

    From: St. Louis Fed

    What to do?

    Saving Solutions

    Behavioral economists have several practical “nudges” that could encourage us to save more. Richard Thaler and Cass Sunstein have described a default saving option that people would actively have to reject. Or maybe the answer is some form of pre-commitment before the actual time to make the saving decision arrives.

    My favorite though is getting to know our future selves better.

    In one study, researchers said that because our elderly selves are strangers, we have less inclination to help them. By meeting our older self, though, we might display a bit less “intertemporal” selfishness and save more for him or her.

    Using virtual reality software, they tested their theory. Their basic approach was to “age morph” young people into their 70 year old selves and then to let the young person “meet” his older version. In several different study designs, researchers compared saving behavior between people who saw themselves at retirement age and others who did not. As they predicted, the individuals who saw the older version of themselves saved more. The saving even increased when experimenters had those self images respond happily or sadly to amounts of savings.

    Our Bottom Line: Intertemporal Discounting

    Whether saving cookies or money, we are looking at intertemporal discounting. Intertemporal just refers to two time periods and discounting involves giving less value to a commodity.

    People who eat cookies now rather than saving some for later have bestowed those future cookies with little value–a larger discount. So too with saving. When we decide to save minimally, we are giving the future a high discount because it has little value to us.

    In behavioral economics, by introducing us to our future selves, researchers are hoping we will give the future less of a discount. They are hoping to help us choose “larger later” rather than “sooner smaller.”

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  • everyday economics, behavioral economics, expectations. a self-fulfilling prophecy.

    Why Are We Still Short on Female CEOs?

    Jan 19 • Behavioral Economics, Businesses, Demand, Supply, and Markets, Economic History, Economic Thinkers, Education, Gender Issues, Regulation, Thinking Economically • 764 Views

    Our story starts in a laboratory with some rats. Curious if experiments reflect bias, Harvard professor Robert Rosenthal falsely labeled average rodents as either smart or dumb. His students assumed the labels were accurate.

    Where are we going? To how an expectations bias creates a gender gap.

    But first, the experiment…

    Rats and Expectations

    In a series of maze experiments, the “smart” rats’ performance far exceeded what the dumb rats achieved. In addition, the smart rats tended to have more appealing attributes. Tamer, cleaner, more pleasant, they were more likable.

    Dr. Rosenthal saw that unknowingly, his students had treated the rats differently. Perhaps because of their affinity for the smart ones, they handled the “bright rats” more frequently and more gently. As I heard Dr. Rosenthal explain in a podcast, touch affects a rats’ performance.

    You can see below that the “smarter” rats’ navigated their T-mazes with increasing cleverness.

    Behavioral economics and expectancy bias

    Based on Rosenthal and Fode (1963)

    Dr. Rosenthal’s research took me to female CEOs and corporate directors. Again, expectations play a role. I suspect that when we see more women running businesses, their presence becomes a self-fulfilling prophecy.

    Expectations Bias in the Board Room

    Looking at S&P 500 companies, Catalyst reports that only 23, a meager 4.6 percent of all CEOs are women.

    Behavioral economics and the expectations bias that keep women out of the boardroom

    Tweaking our perspective, we can compare women’s share of board seats at U.S stock index companies with the number in Europe.

    First, the U.S.:

    Behavioral economics, women on U.S. corporate boards and expectations bias

    From: Catalyst

    The higher European numbers primarily reflect regulatory mandates:

    Behavioral economics, the gender gap and women on European corporate boards

    From: Catalyst

    Our Bottom Line: The Khasi

    And finally, always my favorite, let’s not forget the message from the Khasi:

    Located in Northeast India, the Khasi is a matrilineal society numbering close to 1 million (2011). From birth, women experience a female world. Their households are led by females, businesses are run by women, property can be inherited only by women. When University of Chicago researchers quantified male and female tendencies to compete, the Khasi women got the top grades.

    In a Khasi maternity ward, you might hear cheering when a girl is born but, “‘oh okay, he’ll do” for a boy.

    Or, if you visit a Khasi home…

    “When we visited the Khasi household of a youngest daughter, if a man (obviously the husband) came first to greet us, he always said ‘please wait, my wife (or mother-in-law) is coming.’ And it was the wife who entertained us…while her husband remained silent in the corner of the room, or in the next room.”

    And this returns us to why we have so few female CEOs. Whether looking at the Khasi or the U.S corporate world, expectations bias shapes who is at the top.

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  • everyday economics, behavioral economics and exercise expectations

    Explaining the Health Club Memberships We Don’t Use

    Jan 18 • Behavioral Economics, Businesses, Demand, Supply, and Markets, Economic Thinkers, Entertainment, Health Care, Innovation, Labor, Lifestyle, Sports, Thinking Economically • 458 Views

    Behavioral economics and gym memberships

    During 2013, 52.9 million people–many who rarely exercised–spent almost $23 billion at health and fitness clubs in the U.S.

    Where are we going? To how behavioral economics explains why we spend a lot not to work out.

    The Attraction

    Planet Fitness, a national health club chain, gives away three million slices of pizza each year. The pizza is a membership perk. Monthly, Planet Fitness has a free pizza night and a bagel breakfast. According to the chain’s founder, his competition targets the people who want to work out regularly. His market is the people who do not.

    Planet Fitness is a budget chain with membership as low as $10 a month. The low price is the incentive to join and remain. Estimated by one employee, membership at her Upper West Side NYC location is close to 6,000 but the equipment can accommodate no more than 300 people. Because members seem to prefer the bagel breakfasts, the cardio and weight equipment do not matter.

    Even for the pricer establishments like Equinox, the focus is “wellness offerings” that, at one NJ location, begins with  “a landscaped green wall, cobblestone drive and a grand barrel vault wood ceiling…” According to a health club architect, the design is supposed to resemble a bar when you enter. Taking one reporter on a tour, he explained that he hides the serious workout equipment in a separate room downstairs.

    The Cost

    Health club payment plans tend toward three basic options. You can pay per visit, per month or per year. An initiation or joining fee is also typical. While social media indicate membership charges can be negotiable, Equinox says that it charges a $200 initiation fee that it would refund for 12 work-outs in 30 days and a monthly charge in the vicinity of $80 to $100.

    So, combine a pleasant workout environment, a place to gather with friends and an affordable upfront price and you get a deal most people cannot refuse.

    But why?

    Our Bottom Line: Behavioral Economics

    Our health club membership behavior has a bigger message:

    We inaccurately perceive our future selves. Whether under saving for retirement or over planning our visits to the gym, we let our current outlook cloud a potential future reality. Some behavioral economists call this a projection bias.

    Pre-commitment is attractive. it makes many of us feel virtuous, we think our peers will admire us, and it locks us in to our virtuous decision.

    Paying upfront, monthly or annually, diminishes the transaction costs. Continuing is the default decision. To cancel, we have to do more.

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