Tag Archives: Thinking Fast and Slow

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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11.12.2012 | Behavioral Economics: When Do We Minimize Risk?

With Election Economics having concluded, for the next 4 weeks, Monday posts will focus on topics that relate to behavioral economics.

Let’s start with Hurricane Sandy and my own NJ neighborhood. Really though, we will be looking at how many of us manage risk.

After August 2011 Hurricane Irene, I lost power for 8 days and assumed it would never happen again. Less than 2 months later, with the October 2011 snowstorm, I again lost power for 8 days. After the second storm, my perception of the risk of losing power had changed and I soon decided to purchase a residential generator.

Economics Nobel Laureate, psychologist Daniel Kahneman explained my behavior. First of all, displaying “availability bias,” I began to overestimate the probability of an event because I could recall and therefore imagine it much more clearly.

And then I became a part of an “availability cascade” through which a public reaction conveys growing alarm about a future unpredictable event. Last year, I participated in “availability cascade” within my own neighborhood. Seeing an increasing number of neighbors purchase generators, I believed a generator was necessary. Had I looked at the probability of such an event during a longer time frame, I might have concluded it was not as likely.

Now, after Hurricane Sandy, many more of us might be reacting to an “availability bias” and “availability cascade.”

Describing the businesses that benefit from disasters, a lead article in the NY Times Sunday Business section reported that residential generator sales are soaring. At Wisconsin based Generac Power Systems, they are running 3 shifts 6 days a week to meet the change in demand from Sandy. One NJ contractor says he is booked through January 8 and has 4 or 5 neighbors appear when he arrives to give an estimate at a home. Are we observing examples of post-Hurricane Sandy availability bias–overestimating future probability–and availability cascade–emotional public reaction that spreads?

And a final fact: Availability bias and cascade worked in my favor. For Hurricane Sandy, I had a generator back-up when we lost power for 12 days. After other natural and manmade disasters though, they have resulted in a misallocation of public and private resources.

Sources and Resources: You can read the NY Times article, “The Mad Max Economy,” here while my behavioral economics analysis is based on sections of the Daniel Kahneman book, Thinking Fast and Slow.

Posted by: adminEcon
Tags: availability cascade, availaility bias, behavioral economics, Cass Sunstein, Daniel Kahneman, decision-making, Generac Power Systems, insurance, residential generators, risk, Thinking Fast and Slow
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06.01.2012 | Bogeys, Birdies and the Eurozone

Analyzing more than 1.6 million putts, including Tiger Woods, 2 University of Pennsylvania economists concluded that professional golfers putt better when avoiding a bogey (a stroke over par) than when trying for a birdie (a stroke under par). The reason? Our brains are wired to worry more about loss than gain.

Writing in The New Yorker, financial journalist James Surowiecki relates loss aversion to Greece, Germany, and eurozone negotiations. Surowiecki points out that avoiding a Greek default and departure from the euro zone–a Grexit–would have a beneficial ripple. The Greek economy, the peripheral eurozone nations like Italy and Portugal, banks and Germany would benefit.

Rather than working together, though, Greece and Germany are ”fixated on what is fair.” And, because a fairness focus always biases us toward ourselves, our self-interest and what we perceive is right, neither Greece nor Germany is emphasizing the big picture. One sees austerity as huge unfairness. The other sees bailout as unfair assistance. Perceiving its own position as fair, each is engaging in loss aversion when it refuses to compromise.

Surowiecki says Europe needs to aim for what is possible–not what is fair.

And that returns us to golf. What is possible is like the birdie. It is a gain–a gain that golfers and politicians and voters pursue less vigorously than the bogey.

Starting with economics Nobel laureate, psychologist Daniel Kahneman, and his recent book, Thinking Fast and Slow, you might enjoy reading about the behavioral implications of loss aversion (Chapter 28). Particularly interesting, in How We Decide, journalist Jonah Lehrer takes loss aversion to investing. Also, the University of Pennsylvania putting study, “Is Tiger Woods Loss Averse?” is here and The New Yorker article on fairness in here. Keeping loss aversion in mind, here is a totally different perspective from CNN that says the eurozone solution is Germany’s departure and here, The Economist takes us to Spain’s banks.

Posted by: adminEcon
Tags: Daniel Kahneman, eurozone, fairness, Germany, Greece, Jonah Lehrer, loss aversion, Thinking Fast and Slow
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