Tag Archives: Dan Ariely

12.03.2012 | Behavioral Economics: Better than a Psychiatrist

After reading Murder at the Margin, some of my students suggested in essays that we do not need a psychiatrist to explain human behavior. Instead, just ask a behavioral economist. Let’s give it a try…

Defaulting:

In life, we tend to take the default selection. So whether downloading software or selecting a spouse, be sure the default is best for you. And if you are the producer, know that a default will shape the response for your good or service.

Framing:

Be aware that what precedes a decision shapes its content. If a gallon of gas has gone down from $5.00 to 4.00 to $3.50, we are pleased with $3.50. However, when prices climb to $3.50, it sounds high. Similarly, told before a serious operation that 90 people out of 100 survive, most feel optimistic. Framed instead by the fact that 10 people out of 100 die, the prognosis alarms doctors and patients.

Automatic decisions:

Watch out for your automatic/nonthinking response. Making a decision, people typically have an instantaneous automatic response and one that involves more thinking. So, when faced with a “stop sign” that says, “go,” at first we stop although the sign instructs the opposite. With product design also, our automatic response counts. Take, for example, stovetop knob design. Shown by the first diagram below, many stovetops have a knob line-up that prevents us from responding automatically. The second diagram, below, represents a more functional design.

Our Bottom Line: Because incentives that are not always rational shape how we act at home, at work, and in response to government, behavioral economists can do a good job of explaining life and suggesting how to design policy.

Sources: For further behavioral economics insight, I not only recommend the source of all of my above examples, Nudge by Richard Thaler and Cass Sunstein, but also Thinking, Fast and Slow by Daniel Kahneman, Predictably Irrational by Dan Ariely and Wait by Frank Partnoy. For a more academic look at the connection between incentives and behavior, this paper provides insight. And here, you can read more about Murder at the Margin, a mystery whose protagonist is an economics professor who solves a murder using behavioral economics.

Stove top knob line-ups: In the bottom diagram, you can match the knob to the burner automatically but not with the first one.

Monday Behavioral Economics Posts

Posted by: adminEcon
Tags: automatic response systems, behavioral economics, Cass Sunstein, Dan Ariely, Daniel Kahneman, framing, Frank Partnoy, Murder at the Margin, Nudge, psychology, Richard Thaler, stovetop design, Thinking Fast and Slow, understanding human behavior, Wait
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11.26.2012 | Behavioral Economics: Insider Trading

Did you know that many college professors have encountered the dead granny phenomenon?

Discussing dishonesty, behavioral economist Dan Ariely tells us that before a college midterm, a student’s grandmother is 10 times more likely to die and before a final exam, 19 times. In fact, failing students experience even more “calamity” because their grandmothers are 50 times more likely to perish before a major exam.

Here, Ariely connects the fabrications to “depletion.” When we run out of energy, we also have less of the will power that preserves honesty.

The WSJ graphic, that follows perfectly illustrates how our “cognitive flexibility” can encourage or constrain dishonesty.

The graphic, can also take us to the former SAC Capital Advisors employee who was accused of alleged insider trading. First, some background on SAC:

SAC is a hedge fund that manages close to $13 billion.
Tough to precisely define, a hedge fund buys and sells, sometimes within milliseconds, countless types of securities and security products. When they sell short, they are benefiting from a stock price going down.
SAC’s average annual return for 18 years (but not 2008 when they were down 19%) has been publicized as an impressive 30%.
At approximately 100 million shares a day, their trading volume is massive.

The charges against the former SAC employee involved information he allegedly received about pharmaceutical test results. If indeed he did receive a secret phone call detailing disappointing results at Elan and Wyeth on which his stock trading decisions were based, then his transactions, involving hundreds of millions of dollars, were illegal.

The WSJ graphic, provides clues about why people might engage in insider trading. In a chapter from The (Honest Truth About Dishonesty, on “Collabrative Cheating,” Ariely says that sometimes, the social norms within a group encourage us to engage in “altruistic cheating.” We care about the group with whom we work. We realize that we want and need our supervisors to approve of our decisions. As a result, each group member might “bend the rules” to keep everyone happy. And furthermore, as he also points out, punishment is not necessarily a deterrent.

Indeed, whether on Wall Street or at school when we are exhausted, overwhelmed, and unprepared for the final exam, our “cognitive flexibility can lead to dishonesty. As economists, it leaves us pondering how incentives can be used to elicit the best behavior.

Sources and Resources: I do recommend this video discussion about dishonesty between Yale researcher Laurie Santos and Duke professor Dan Ariely. Ariey also describes his ideas in this WSJ article and his book, The (Honest) Truth About Dishonesty and for more on SAC, here is a 2010 Bloomberg article and a recent discussion of insider trading charges against a former employee.

Monday Behavioral Economics Posts

Posted by: adminEcon
Tags: behavioral economics, cognitive flexibility, collaborative altruism, collaborative cheating, Dan Ariely, dead granny phenomenon, Elan, insider trading, Laurie Santos, Mathew Martoma, SAC Capital Advisors, Steven Cohen, The (Honest) Truth About Dishonesty, Wyeth
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11.19.2012 | Behavioral Economics: The Best Gifts

A gift can be worth much more or less than its price tag. It just depends on whether you are the giver or the receiver.

One of the best gifts I have ever gotten was a book of car wash coupons. Happily, I used every one, each time feeling that I had gotten something for free. The value of the gift to me was equal to the value that the giver had paid to say thanks for driving her daughter to school every morning.

According to economist Joel Waldfogel, my experience was unusual. What we give rarely is worth as much to the recipient. As a result, he says that there is an “orgy of value destruction” during the holidays. If you are willing to pay only $25 for that $50 sweater your Aunt Minnie gave you, then $25 of value is destroyed. Called deadweight loss, Waldfogel estimates that 18 percent of the value of all gifts given during the December holidays disappears.

Is the answer cash? Not necessarily. Explained by behavioral economist Dan Ariely, the reason might be that we have market norms and social norms. A stranger asked to help someone move a sofa says no when offered a small amount of cash. However, when asked as a favor, more people willingly assisted. The former was a transaction. The second was an act of good will.

The good will takes us to gift giving. Even when value is lost on the recipient’s side, it might be gained with the giver. After all, if the pleasure of giving a $50 sweater could “add” $25 to its value and make it worth $75 to your Aunt Minnie, then that 18 percent deadweight loss is eliminated.

Maybe you think this behavioral analysis is ridiculous. But, the combination of gifts’ deadweight loss and the need to judge gifts with social norms might be why gift cards are so popular. It also explains why my car wash coupons were worth more to me than their price tag.

Sources and Resources: Joel Waldfogel conveys the academics behind his ideas in his paper, more informally explains his book, Scroogenomics, in this video, and summarizes his conclusions in this NPR segment. My top recommendation, though, is Dan Ariely’s book, Predictably Irrational in which I read about social and market norms (Chapter 4).

Past Monday Behavioral Economics Posts

Managing Risk: 11/12

Posted by: adminEcon
Tags: behavioral economics, Christmas, cost benefit analysis, Dan Ariely, gift cards, gift giving, good will, Hanukkah, Joel Waldfogel, market norms, predictably irrational, Scroogenomics, social norms, value destruction
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10.09.2012 | California Consumers and Gas Prices

How might California be responding to $5.00 gas?

Let’s start with bread machines.

Behavioral economist Dan Ariely explains that when one of the first sellers of bread machines placed it on the shelf, few people were interested because they could not judge the price. At that point, market researchers suggested selling a much higher priced, larger model nearby. The result? As Ariely said, “Since one was clearly much larger and much more expensive than the other, people didn’t have to make their decision in a vacuum. They could say, ‘Well, I don’t know much about bread makers, but I do know if I were to buy one, I’d rather have the smaller one for less money.’ And that’s when the bread makers flew off the shelves.”

For the price of gas also, relativity matters. Called reference pricing, we judge the price of regular by where it has been. If the price of gas is rising, used to spending less, consumers have a lower reference price, like $3.50, and respond negatively to $3.75. However, when prices descend, the reference price is higher, maybe $4.00 and $3.75 sounds rather good.

Giving his interpretation of relativity, economist James Hamilton believes that most of us ignore rising gas prices until they move beyond their high for the previous 3 years. It appears that, at an average of $4.66 (graph, below), California is there.

Here is where average gas prices have been in California and the US for the past 36 months (from gasbuddy.com):

Sources and Resources: I recommend Predictably Irrational, the source of my Dan Ariely quote (p. 15) and a good read. For more on “framing,” a phenomenon that resembles reference pricing, Daniel Kahneman’s Thinking Fast and Slow is fascinating. And, for the academic perspective on gas and oil James Hamilton’s blog, Econbrowser provides a wealth of information. Finally, econlife tells more about gas prices here.

Posted by: adminEcon
Tags: bread making machines, California, consumption expenditures, Dan Ariely, Daniel Kahneman, gas buddy, gas prices, James Hamilton, price elasticity, price framing, reference pricing
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06.11.2012 | Was That Birthday Card Really Free?

Have you ever been delighted that you got something for free? I was until I read “the cost of zero cost” in Dan Ariely’s book, Predictably Irrational.

My story begins at a Papyrus store in NYC. About to pay for several birthday cards, the salesperson told me I would get one free if I just added another card to my purchase. Unfortunately, I did. I spent another 5 minutes that I could have used elsewhere to choose 2 cards that I did not need.

To explain our emotional response to “free,” Ariely asks the reader to quickly decide between a $10 Amazon gift certificate or a $20 Amazon gift certificate for which you pay $7. Most people in his experiment at a Boston mall selected the “Free” option. But, as you probably realize, the second one is better.

We can’t leave this discussion about “free” without a look at “free shipping.” Do you remember when Amazon told customers they would get free shipping on all orders above a certain amount? Like me, you might have bought 2 books instead of one to get the deal. In France, at the same time, Amazon charged the equivalent of 20 cents-a miniscule amount- for shipping and received no extra orders. Then, when they eliminated the charge, French orders climbed.

Ariely does not mention, though what happens when everyone offers free shipping. Do we perceive it as free anymore? He does say though, that free is a great incentive when government wants us to buy electric cars. Just give free inspections or registration. Preventive health care? Just make it free.

But, is it really free?

Maybe my greeting card was cheaper but the extra time I spent, the 2 unused cards still sitting in my drawer, and the money I could have saved or spent elsewhere made that “free” card rather expensive. I guess our bottom line is, “There is no such thing as a free lunch.”

Here is an excellent discussion of Ariely’s book in the New Yorker.

Posted by: adminEcon
Tags: cost/benefit analysis, Dan Ariely, free lunch, free shipping, opportunity cost, TANSTAFL, utility
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