This document discusses several concepts from behavioral economics including perverse incentives, prospect theory, and the tragedy of the commons. Perverse incentives are incentives that result in unintended negative consequences. Prospect theory suggests that people value gains and losses differently and make decisions based on perceived gains rather than losses. The tragedy of the commons describes how individuals acting in their own self-interest can ultimately deplete a shared limited resource, even when it is clear that it is not in anyone's long-term interest for this to happen. Examples are given for each concept.

2. What is it?
It studies the effects of psychological, social, cognitive and
emotional factors on the economic decisions of individuals and
institutions and the consequences for market prices, returns
and resource allocation
It is primarily concerned with the bounds of rationality of
economic agents and integrates sightings from psychology and
microeconomics theory

3. PERVERSE INCENTIVES
A perverse incentive is an incentive that has an unintended
and undesirable result which is contrary to the interests of the
incentive makers. Perverse incentives are a type of
unintended consequence.
“An incentive that produces an adverse
consequence due to the actions undertaken
to receive the incentive.”

4. EXAMPLES Of PERVERSE INCENTIVES
 In 1902 the governors of
the French Indochinese
colony of Hanoi were
facing a problem with
rats overrunning their
buildings. Their initial
response seemed simple
and ingenious; they
introduced a one-cent
bounty on each rat killed.
Each bounty-hunter only
needed to show a rattail
as evidence of the killing
.
 This led to some
industrious folks
raising rats on rat
farms to collect the
bounty, or simply
chopping off the rats'
tails and releasing
them so they could
reproduce. The more
the government paid
to reduce the rat
population, the more
the rats thrived.
Oops!
 Perverse incentives are
incentives that result in
unintended negative
consequences due to actions
people take to receive the
incentive They are a common
occurrence because decision-
makers don't always think things
through before acting, often with
disastrous results

5. •In another well-known incident,
IBM implemented a pay
structure that paid their
computer programmers by the
line for the code they wrote
•Their goal was to increase the
quality of the code
•As a result, the programmers
found ways to unnecessarily
maximize the line count,
increasing their pay and
reducing the quality of the code

6. PARADOX OF
VALUE

7. INTRODUCING
PARADOX OF VALUE.
This paradox was
proposed by ADAM
SMITH in the 1800s as
a means
understanding the role
utility plays in the
demand price of a
good by differentiating
between total utility
and marginal utility
The problem?
Water though a
necessity is priced
lower than diamonds!
Read
on……

8. •The law of diminishing
marginal utility is important
for resolving this paradox .
•According to the law of
diminishing marginal utility
the price of a commodity is
influenced by its marginal
utility.
•Water provides humans with an
enormous amount of total utility as A LOT
of wants and needs for A LOT of people
•Since water is available in plentiful
quantity than diamonds , its marginal
utility is lower.
•Diamonds, however, are scarce. Because
they are harder to find and attain, our
marginal utility (additional satisfaction),
for adding a diamond to our collection is
much higher than someone offering us
one more drink of water.

9. Example!
•Does paying Rs.50,000 for a Gucci bag compared to Rs.3000 for a solid pair of shoes
make sense?
•From a practical and survival standpoint, it certainly doesn't. In order to get around
and enable our most basic form of transportation (walking), we need shoes to protect
our feet
•They are certainly more important and practical than a bag . The price difference
comes back to the satisfaction, or marginal utility, we get from purchasing a pair of
shoes compared to a Gucci Bag.
• If you were in the middle of the jungle and trying to survive, you might pay more for
those shoes, but until that happens, most of us will continue to pay more for fashion!

10. PROSPECT THEORY
It states that people value gains and losses differently
and, as such, will base decisions on perceived gains
rather than perceived losses.
Thus, if a person were given two equal choices, one
expressed in terms of possible gains and the other in
possible losses, people would choose the former.

11. PROSPECT THEORY &
FRAMING
“We choose between descriptions of
options. Rather than between the options
themselves.”

12. IT’S ALL IN HOW YOU
SPEAK
Honestly, what would you prefer?
A certain win of $250
A 25% chance of winning $1000 or 75% chance of winning nothing?
A certain loss of $750
A 75% chance to loose $1000 and a 25%chance to
loose nothing?
according to
researches it has
been concluded that
people choose
option 1 over option
3 and option 2 over
option 4!

13. Industries thrive on this
psychology!
Banking
Insurance
Companies on stock exchange

14. THE TRAGEDY OF COMMONS
The tragedy of the commons theory assumes
that when making decisions, people take
the course of action that maximises their
own utility. However, if many people seek
to do this, the net effect may be to deplete
a resource making everyone worse off in
the long run

15. Common Goods :
 This means that anyone has access
to the good, but that the use of the
good by one person reduces the
ability of someone else to use it.
 A classic example of a common
good are fish stocks in international
waters; no one is excluded from
fishing, but as people withdraw fish
without limits being imposed, the
stocks for later fishermen are
potentially depleted.

16. Hardin’s parable involves
a pasture "open to all." He
asks us to imagine the
grazing of animals on a
common ground.
Individuals are motivated
to add to their flocks to
increase personal wealth.
Yet, every animal added
to the total degrades the
commons a small amount.
Although the degradation
for each additional animal
is small relative to the
gain in wealth for the
owner, if all owners
follow this pattern the
commons will ultimately
be destroyed..

18. GARBAGE INDEX
I am not all that bad,
guys!!!!
Garbage is dirty, stinky and
once it's out of sight — for most of
us — it's out of mind. But the truth is, garbage is
a good indicator
of the economy.

19. The Concept
Logically, the correlation between trash and
GDP is that the stronger the economy, the
more stuff people buy. And the more people
demand, the more waste they produce.
Obviously, when they buy new things, they
tend to throw out old ones.
Simply because if you create things you also have to throw
other goods out. It's the circle of life for the economy. Just
about everything that gets made, from a half-eaten
McDonald’s hamburger to the cover for your Apple iPhone,
eventually finds its way to the trash bin.

20. •One of the most recent attempts is
the "Trash Index," developed by
economist Michael McDonough
•His index explores the relationship
between the gross domestic product
and the number of train cars full of
trash that are shipped to landfills
•When the economy is booming, there
are plenty of trains, but when it's in
trouble, the flow stops

21. The US ranks highest in GDP and waste production,
each person producing over 2.5 kilograms of trash per
day. Following narrowly behind are large, developed
economies like Germany, Japan. Further down the
curve further are the emerging economies of Mexico,
China, Brazil and India.

22. http://www.investopedia.com/university/behavioral_finance/behavioral11.asp
http://www.businessdictionary.com/definition/perverse-
incentive.html#ixzz3kvbIHtlU
https://www.youtube.com/watch?v=WYA1y405JW0
http://www-personal.umich.edu/~rdeyoung/tragedy.html#sthash.9HJai7sN.dpuf
http://faculty.som.yale.edu/nicholasbarberis/ptapp_final.pdf
http://www.behavioraleconomics.com/mini-encyclopedia-of-be/prospect-theory/
http://www.investopedia.com/university/behavioral_finance/behavioral11.asp
http://www.sjsu.edu/faculty/watkins/prospect.htm
http://www.princeton.edu/~kahneman/docs/Publications/prospect_theory.pdf
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