Behavioral Economics and Decision Making

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Behavioral Economics and Decision Making

  1. 1. Behavioral Economics Judgment and Decision Making Consumer Behavior Neeru Paharia Doctoral Candidate Harvard Business School
  2. 2. Standard Economic Theory People are Rational
  3. 3. Standard Economic Theory People are Craaaaaaazy!
  4. 4. The Brain: the Elephant and the Rider The Emotional Elephant Limbic System : coordination, motivation, memory, emotions. This is the older, bigger, more developed part of our brain Orbitofrontal cortex : emotional analysis, feeling of wanting or avoiding, pleasure and pain, approach and avoidance
  5. 5. The Brain: the Elephant and the Rider The Emotional Elephant Limbic System : coordination, motivation, memory, emotions. This is the older, bigger, more developed part of our brain Orbitofrontal cortex : emotional analysis, feeling of wanting or avoiding, pleasure and pain, approach and avoidance More emotional, irrational, intuitive, older, bigger, and faster
  6. 6. The Brain The Rational Rider Neo-cortex : thinking, planning, decision-making, time traveling, homo economicus. This is the newer, smaller, less developed part of our brain
  7. 7. The Brain The Rational Rider Neo-cortex : thinking, planning, decision-making, time traveling, homo economicus. This is the newer, smaller, less developed part of our brain Less emotional, more logical, rational, slower, and deliberate. The voice in your head.
  8. 8. The Elephant in Control The elephant part of our brain is bigger, and faster than the rider part of our brains. Many decisions that we think are unbiased and rational are based on an automatic sometimes unconscious reactions driven by the emotional elephant. Unless of course… Giddy up Elephant!
  9. 9. Evolutionary Automatic Responses Beauty and symmetry Disgust (flies) Smelling Shirts Babies and snakes Ovulation (strippers and looks)
  10. 10. Implicit Attitudes People who hold no explicit hostilities towards other races and genders may be implicitly biased. We make connections much more quickly between pairs of ideas that are already related in our minds than we do between pairs of ideas that aren’t familiar to us.
  11. 11. Implicit Attitudes Measures unconscious racial attitudes
  12. 12. Implicit Attitudes 75% of Caucasians exhibit pro Caucasian implicit attitudes 50% of African Americans exhibit pro Caucasian attitudes
  13. 13. Fictitious resumes were sent to help-wanted ads in Boston and Chicago. Resumes were randomly assigned African American or White sounding names. Emily and Greg vs. Lakisha and Jamal?
  14. 14. Fictitious resumes were sent to help-wanted ads in Boston and Chicago. Resumes were randomly assigned African American or White sounding names. Emily and Greg vs. Lakisha and Jamal? White names received 50% more call backs than black names
  15. 15. Priming Studies and Automatic Associations Rudeness Elderly People Hot and Cold beverages Money African American Man Romance
  16. 16. Temporal Studies (hyperbolic discounting) What do you choose: 100 dollars today or 101 dollars tomorrow? versus 100 dollars in 50 days or 101 dollars in 51 days
  17. 17. Temporal Studies (hyperbolic discounting) What do you choose: 100 dollars today or 101 dollars tomorrow? versus 100 dollars in 50 days or 101 dollars in 51 days FMRI results show the emotional side wants less money today and the cognitive side wants more money in the future
  18. 18. Unconscious versus Conscious Thought Paintings 4 Apartments each with 12 attributes. One is objectively better. How do you choose the best one?
  19. 19. Unconscious versus Conscious Thought Paintings 4 Apartments each with 12 attributes. One is objectively better. How do you choose the best one? Intuition is better in complex decisions. The elephant is bigger than the rider.
  20. 20. The Elephant is Narcissistic Dennis the Dentist Phil lives in Philadelphia Judy marries Joe First three letters of your name Facial morphing
  21. 21. The Elephant is Narcissistic Dennis the Dentist Phil lives in Philadelphia Judy marries Joe First three letters of your name Facial morphing People like people who mimic them. Foot tapping. Waiters get bigger tips if he mimics his customers.
  22. 22. Positive Illusions 1 million students. 70 % thought they were above average leaders. 2% thought they were below average. 94% of professors think they do above average work How much would you donate out of $5? Said: $2.50 Actual: $1.53 How likely would you hire an underpaid domestic worker? Your neighbor? Everyone is in the 85 th percentile in driving skills
  23. 23. Positive Illusions 1 million students. 70 % thought they were above average leaders. 2% thought they were below average. 94% of professors think they do above average work How much would you donate out of $5? Said: $2.50 Actual: $1.53 How likely would you hire an underpaid domestic worker? Your neighbor? Everyone is in the 85 th percentile in driving skills People think they are more honest, cooperative, rational, better drivers, and more intelligent than others.
  24. 24. Harvard MBA students claim to do 139% percent of the work. Over claiming credit found in marriages, academia, athletics, and fundraising. Greater the over claiming the less people want to work together in the future. Perspective taking reduces these effects. Over claiming credit
  25. 25. Social Stuff: Reciprocity Humans are ultra-social creatures. It is in our interest survival interests to cooperate with other. We usually play tit for tat. Parts of our brain keep track of this. Things like gratitude and vengeance regulate it. Giving 5 to fill out a survey gets more compliance than telling people you will mail them 50 dollars when they fill it out.
  26. 26. In-Group Out-Group Bias <ul><li>Same final digit of social security number </li></ul><ul><li>Random assignment by coin toss </li></ul><ul><li>Color of shirt </li></ul>
  27. 27. In-Group Out-Group Bias <ul><li>Same final digit of social security number </li></ul><ul><li>Random assignment by coin toss </li></ul><ul><li>Color of shirt </li></ul>Favor in-group members even if they are associated by a coin toss
  28. 28. Like in group brands: Students like brands more used by their in-group members than their out group members Abandon brands: “ Cool students abandoned the “Live strong” bracelet when the “nerds” next door wore them too In-Group Out-Group Bias
  29. 29. Fairness Homo Economicus? Dictator Games: give 1/3 Ultimatum Games: $20 half of people give $10. People reject $3 but accept $7.
  30. 30. Fairness Homo Economicus? Dictator Games: give 1/3 Ultimatum Games: $20 half of people give $10. People reject $3 but accept $7. FMRI reject triggers emotional reaction, accept triggers more cognitive reactions
  31. 31. Tie the Riders Hands?
  32. 32. Tie the Riders Hands? Mmmmm… Chocolate cake good.
  33. 33. DO IT! DON’T DO IT! Moral Judgments Indirect harm triggers the cognitive brain. Direct harm triggers the emotional brain.
  34. 34. DO IT! DON’T DO IT! Moral Judgments Indirect harm triggers the cognitive brain. Direct harm triggers the emotional brain. We evolved not to harm people directly. Division of labor enables greater harm.
  35. 35. People who score poorly on social intelligence tests find reasons to discount the test. Coffee drinkers find flaws in tests that say coffee is unhealthy. Level of outrage predicts prison sentences The Elephant Tells the Rider What to Think
  36. 36. People who score poorly on social intelligence tests find reasons to discount the test. Coffee drinkers find flaws in tests that say coffee is unhealthy. Level of outrage predicts prison sentences The Elephant Tells the Rider What to Think If the argument “makes sense” we don’t look for any counter evidence. We think we are objective but the rider acts like a lawyer for the elephant.
  37. 37. Students given complex information about the sale of a real company and asked to estimate the company’s value as the buyer’s auditor or the seller’s auditor. Bias and Conflicts of Interest
  38. 38. Students given complex information about the sale of a real company and asked to estimate the company’s value as the buyer’s auditor or the seller’s auditor. Bias and Conflicts of Interest Seller’s auditor estimated the value to be 30% more than the buyer’s auditor. Similar effects were found with real auditors. Real financial incentives didn’t help.
  39. 39. 5 dollar wine as 5 dollar wine, or 35 dollar wine. Tastes better when it’s more expensive. The Elephant is Really Powerful
  40. 40. 5 dollar wine as 5 dollar wine, or 35 dollar wine. Tastes better when it’s more expensive. The Elephant is Really Powerful FMRI studies find that participants actually feel more pleasure with the expensive wine.
  41. 41. Seashells and Tide? People who saw seashells were more likely to say they liked Tide, and came up with many good reasons for why they liked it.
  42. 42. Seashells and Tide? People who saw seashells were more likely to say they liked Tide, and came up with many good reasons for why they liked it. “ It smells good.” or “My mom used it when I was a kid.”
  43. 43. Sweatshops are the only realistic source of income for workers in poorer countries; Without sweatshops poorer countries couldn’t develop; The use of sweatshop labor is okay because otherwise these products wouldn’t be affordable to low-income people, The use of sweatshop labor is okay because companies must remain competitive. Moral Justification
  44. 44. Sweatshops are the only realistic source of income for workers in poorer countries; Without sweatshops poorer countries couldn’t develop; The use of sweatshop labor is okay because otherwise these products wouldn’t be affordable to low-income people, The use of sweatshop labor is okay because companies must remain competitive. Moral Justification Much more likely to agree if you consider a really nice pair of jeans than just an okay pair of jeans
  45. 45. Negativity Bias: missing a positive cue (food) is much less catastrophic than missing a negative cue (predator). We are wired so that bad is stronger than good. Prospect Theory and Loss Aversion
  46. 46. Negativity Bias: missing a positive cue (food) is much less catastrophic than missing a negative cue (predator). We are wired so that bad is stronger than good. Prospect Theory and Loss Aversion Pain of losing a $100 is greater than the joy of winning $100. We are generally risk averse.
  47. 47. Scenario 1: A. Getting two $100 parking tickets in one day (for a total of $200). (-20) B. Getting one $200 parking ticket. (-15) Scenario 2: A. Winning two $100 lotteries in one day (for a total of $200). 10 B. Winning one $200 lottery. 7.5 Win $100 Lose $100 5 7.5 -10 -15 Loss Aversion
  48. 48. Scenario 1: A. Getting two $100 parking tickets in one day (for a total of $200). (-20) B. Getting one $200 parking ticket. (-15) Scenario 2: A. Winning two $100 lotteries in one day (for a total of $200). 10 B. Winning one $200 lottery. 7.5 Win $100 Lose $100 5 7.5 -10 -15 Loss Aversion Better to integrate losses and segregate gains.
  49. 49. Imagine you are given a choice of gambles. You either have a 100% chance of losing $100 or a 50% chance of losing $200. Imagine you are given a choice of gambles. You either have a 100% chance of winning $100 or a 50% chance of winning $200. Risk Taking
  50. 50. Imagine you are given a choice of gambles. You either have a 100% chance of losing $100 or a 50% chance of losing $200. Imagine you are given a choice of gambles. You either have a 100% chance of winning $100 or a 50% chance of winning $200. Risk Taking Hate losing. Willing to take a risk to avoid it.
  51. 51. Scenario 1: Imagine that your country is preparing for an outbreak of a disease which is expected to kill 600 people. Given the choice between two vaccination schedules, Program A which will save 200 and Program B which will save all 600 with probability 1/3, and save no one with a probability of 2/3. Scenario 2: Imagine that your country is preparing for an outbreak of a disease which is expected to kill 600 people. Given the choice between two vaccination schedules, Program C which will allow 400 people to die and Program D which will let no one die with probability 1/3 and all 600 will die with probability 2/3. Framing Disease Problem
  52. 52. Scenario 1: Imagine that your country is preparing for an outbreak of a disease which is expected to kill 600 people. Given the choice between two vaccination schedules, Program A which will save 200 and Program B which will save all 600 with probability 1/3, and save no one with a probability of 2/3. Scenario 2: Imagine that your country is preparing for an outbreak of a disease which is expected to kill 600 people. Given the choice between two vaccination schedules, Program C which will allow 400 people to die and Program D which will let no one die with probability 1/3 and all 600 will die with probability 2/3. Framing Disease Problem Real impact for major policy decisions!
  53. 53. Imagine there was a snow storm and shovels are all of a sudden in high demand. Consider each of the following scenarios: Case A: The shovel’s original price is $20. Due to increasing demand, the owner of the store raises the price by 25% and now the shovel costs $25. Case B: The shovel’s original prices was $25 but it has been on a promotion for $20 for the last year. The owner decides to repeal the promotion and the price goes back up to $25. How unethical? Framing and Ethics
  54. 54. Imagine there was a snow storm and shovels are all of a sudden in high demand. Consider each of the following scenarios: Case A: The shovel’s original price is $20. Due to increasing demand, the owner of the store raises the price by 25% and now the shovel costs $25. Case B: The shovel’s original prices was $25 but it has been on a promotion for $20 for the last year. The owner decides to repeal the promotion and the price goes back up to $25. How unethical? Framing and Ethics More unethical to raise price then remove sale. Reference point.
  55. 55. Case A: Imagine you have been exposed to a rare and fatal disease and now face a .001 chance of painless death within two weeks. How much would you be willing to pay for a vaccine that would eliminate this risk? Case B: How much compensation would you demand to participate in a medical experiment where you will face a .001 chance of a quick and painless death? Framing Status Quo
  56. 56. Case A: Imagine you have been exposed to a rare and fatal disease and now face a .001 chance of painless death within two weeks. How much would you be willing to pay for a vaccine that would eliminate this risk? Case B: How much compensation would you demand to participate in a medical experiment where you will face a .001 chance of a quick and painless death? Framing Status Quo Depends on reference point. Once you have been exposed the loss has been incorporated.
  57. 57. Group A is given pens and asked if they want to exchange for chocolate. Group B is given a token they can buy pens or chocolate. Endowment Effect
  58. 58. Group A is given pens and asked if they want to exchange for chocolate. Group B is given a token they can buy pens or chocolate. Endowment Effect Group A is more likely to keep the pen. Group B is more likely to choose chocolate. Group A sees trading the pen as a loss.
  59. 59. Automatic enrollment and opt out Future raises will go into retirement plan 401K Policies
  60. 60. Automatic enrollment and opt out Future raises will go into retirement plan 401K Policies Future raises are never registered as a loss
  61. 61. FMRI studies show that the pain centers of the brain light up when one has to part with one’s cash. The Pain of Paying
  62. 62. FMRI studies show that the pain centers of the brain light up when one has to part with one’s cash. The Pain of Paying Less pain with credit.
  63. 63. You’re at a store and learn $30 calculator on sale at the other store for $15. Worth a 10 minute drive? You’re at a store buying a car and learn the $45,375 dollar car is on sale at the other store for $45,360. Worth a 10 minute drive? Reference Points: 10 minutes for $15?
  64. 64. You’re at a store and learn $30 calculator on sale at the other store for $15. Worth a 10 minute drive? You’re at a store buying a car and learn the $45,375 dollar car is on sale at the other store for $45,360. Worth a 10 minute drive? Reference Points: 10 minutes for $15? A 10 minute drive is worth $15? What would homo economicus do?
  65. 65. Donate $1 per day to be withdrawn from your account $7 per week for one year Donate $365 a year to be withdrawn from your account $7 per week Reference Point: For Just Pennies a Day…
  66. 66. Donate $1 per day to be withdrawn from your account $7 per week for one year Donate $365 a year to be withdrawn from your account $7 per week Reference Point: For Just Pennies a Day… More likely to donate $1 per day. Reference point is a cup of coffee vs. a new gas grill.
  67. 67. If your boss told you to fire someone without cause, how likely would you do it? How likely would others do it? If your boss told you to release an unsafe product to market how likely would you do it? Others? If your boss told you to shock someone even though they were screaming in pain how likely would you do it? Others? The Classics: Obedience to Authority
  68. 68. Participant is told they are part of a learning experiment, and asked to administer shocks to a “confederate” by the experimenter, an authoritative man in a white lab coat. The Classics: Obedience to Authority
  69. 69. Participant is told they are part of a learning experiment, and asked to administer shocks to a “confederate” by the experimenter, an authoritative man in a white lab coat. The Classics: Obedience to Authority 65% of participants--some with clearly conflicted consciences--delivered the lethal shock. The only duress placed on the subjects was verbal cuing from a man in a white lab coat.
  70. 70. Which line in the second box is the same size as the line in the first box? The Classics: Conformity
  71. 71. What if you were in a group of seven people who on a go around, all agree that the answer is A? You’re the last person in the group to give your answers. What would you say? The Classics: Conformity
  72. 72. What if you were in a group of seven people who on a go around, all agree that the answer is A? You’re the last person in the group to give your answers. What would you say? The Classics: Conformity 37% of participants agree with the group even if the answer is obviously wrong.
  73. 73. A participant is placed alone in a room and is told he can communicate with other participants through an intercom. In reality, he is just listening to an audio recording and is told his microphone will be off until it is his turn to speak. During the recording, one participant suddenly pretends he is having a seizure. The Classics: Diffusion of Responsibility How long the participant waits before alerting the experimenter varies directly with the perceived number of other participants.
  74. 74. When they have too much choice (24 vs. 6) they don’t enjoy choosing, experience more regret, and less satisfaction. Students who wrote essays from a selection of 24 topics wrote worse papers than those who could choose from 6 topics. Random Studies: Over choice
  75. 75. When they have too much choice (24 vs. 6) they don’t enjoy choosing, experience more regret, and less satisfaction. Students who wrote essays from a selection of 24 topics wrote worse papers than those who could choose from 6 topics. Random Studies: Over choice However, people will always tell you they want more choice!
  76. 76. Say your doctor prescribed you a drug that she has a financial stake in somehow. How many of you would want your doctor to tell you this? Random Studies: Disclosure of Conflicts
  77. 77. Say your doctor prescribed you a drug that she has a financial stake in somehow. How many of you would want your doctor to tell you this? Random Studies: Disclosure of Conflicts More likely to listen to your doctor if they disclose the conflict than if they don’t.
  78. 78. Brands use tales of their humble beginnings as part of their branding. “We started in a garage…” External disadvantage with passion (underdog) wins out over advantage with or without passion (top dog) Random Studies: Underdogs and Brand Biography
  79. 79. Brands use tales of their humble beginnings as part of their branding. “We started in a garage…” External disadvantage with passion (underdog) wins out over advantage with or without passion (top dog) Random Studies: Underdogs and Brand Biography People like brands they can identify with, and that inspire them.
  80. 80. Some Good Books: The Happiness Hypothesis Johnathan Haidt Judgment and Decision Making Max Bazerman The Tipping Point and Blink Malcolm Gladwell Nudge Dick Thaler and Cass Sunstein Thank You! Contact Info: Neeru Paharia [email_address] Whasssup!!! The elephant is in charge now!

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