Richard Thaler is known as the father of behavioral economics, and he did his work at the same time as Daniel Kahneman, who gained fame for his work on the same topic as a psychologist. Prior to his papers, economists tended to think that people always acted rationally. Economists would never predict that people would be happy when the bowl of almonds that people were munching right before dinner was taken away, so that their appetite wouldn’t be spoiled. Economists thought that people always acted rationally. Thaler came up with point after point where he realized that that wasn’t true. This book is a story about how he came to realize how irrational we are, and how he slowly proved it, to the chagrin of leading economists of the day.
Note for example how most people respond to extra costs when using a credit card. Paying more is thought of as a surcharge, which is rather disliked. But if it’s a cash discount you’re giving up (with the same effect), then you think of it as just a small opportunity cost for the convenience. Rationally they’re identical, but psychologically, they’re different.
As Thaler tried to convince economists of his ideas, he hit lots of roadblocks. They were used to papers published with real world, or laboratory results, and he had been experimenting with simple survey data. Critics said that in the real world, people wouldn’t make mistakes.
He discovered the endowment effect, which is where you value something more greatly because you have it. You might never buy a $100 bottle of wine, but if one you bought went up in value, you’d never sell it…
He found an irrationality called the transactional utility effect. Utility is defined as the benefit you get out of a transaction. If you buy a watch for $20, it’s because you expect to get more value out of it than other uses of $20. Maybe you’d get $50 of value, but luckily it only costs $20. Transactional utility, is when you get value out of the transaction itself, rather than the item obtained, such as being excited about finding some jeans at 50% off. Transactional utility is negative when you’re getting gouged, and positive when you find a great sale.
He found that people are risk seeking when it comes to losses (we want to avoid sure losses) and risk averse when it comes to gains (we would rather have money in hand, than a chance for more). The “breakeven effect” is where you take extra risk to claw back losses. “House money effect” is where you are more risk seeking when you’ve recently been gifted or won some money.
The “status quo effect” is where you need to be convinced to change your current situation. Personally, I think that’s a good one, because you could imagine the extra transactions people would make if any time they like a house or whatever marginally better, they would just change? Seems applicable to employment and social memberships as well.
He wrote Anomalies for the Journal of Economic Perspectives, which also carried a brain teaser column, which is interesting.
He tells stories about professors who got caught up on analyzing office size square footage in a new building instead of other niceties. And NFL teams who overwhelmingly favor high draft picks and the current year over the next year despite plenty of evidence to the contrary.
Other stories are about how Palm and Shell stock both had episodes where the same stock was effectively trading at vastly different prices.
When trying to convince people to respond to mailings, the phrase “most people pay and you are one of the few delinquent” was the most helpful in getting responses.