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Behavioral economics in 22 slides - showing that we are irrational

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Overview of some key behavioral economic principles - that highlight some of our more irrational tendencies.

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Behavioral economics in 22 slides - showing that we are irrational

  1. 1. Kurt Nelson, PhD Behavioral ECONOMICSin 22 slides
  2. 2. Behavioral Economics fuses… psychology and economics to gain a better understanding of human behavior and decision making.
  3. 3. The following slides overview many Behavioral Economic Principles That show we are not as rational as we would like to think…
  4. 4. Well-defined preferences Decisions maximize all alternatives Makes rational actions Pursues monetary wealth ECONS HUMANS Not sure of preferences Often picks easiest route - satisfice Subject to guilt, fairness, social comparison, desire for luxury
  5. 5. Goal gradient theory – Goal motivation changes as people move closer to target. The closer you get to the target, the greater the motivation is to achieve it. Goal Principles Research: Buy 10 coffees – get one free! 10 coffee punch card Average 15.6 days 12 coffee punch card with 2 pre-punched Average 12.7 days Ran Kivetz, 2006 Illusionary goal progress – Goal motivation increases even when the progress towards the goal is illusionary.
  6. 6. Loss Principles Loss aversion: For most people, the “pain” of a loss is greater than the “pleasure” of an equivalent gain. In other words, people tend to be more motivated to avoid losing $100 than they are to win $100.
  7. 7. Endowment Principles Endowment effect – We ascribe more value to objects / things merely because we own them. Even when that ownership is only for a few minutes long, people tend to value items they own more than items that they do not own. People would pay $4.00 for a coffee cup (before they owned it) People would only sell the same coffee cup for $6.00 once they owned it Thayler
  8. 8. Anchoring Principles Anchoring – People tend to use irrelevant information as a reference for evaluating or estimating an unknown value or new information. When anchoring, people base decisions or estimates on events or values known to them (or that have been primed), even though these facts may have no bearing on the actual event or value. Research: estimate the price of a wireless keyboard after writing down the last two digits of your social security number – expressed as dollars (i.e., if your SSN ended in 74, you would write down $74). The top 20 percent bid an average of $56 for the cordless keyboard; the bottom 20 percent bid an average of $16. $56 $16 Top 20% Bottom 20% Dan Ariely
  9. 9. Reference Principles Reference Point – Tied to Anchoring is the concept of Reference Point: what do you expect to pay for something changes that value that you receive based on the price you pay. If you expect to pay a higher amount than you do, the actual pleasure you receive from the purchase goes up. The corollary is also true. Research: How much would you pay for a beer on a hot day at the beach? Two options were presented as the only place to get beer: fancy hotel or run down convenient store. Same beer, same desire, but willing to pay two different prices. NOTE – friend was going to get beer – so no value is associated with location. $7.25 $4.10 Fancy Hotel Convenient Store $ $ Thayler
  10. 10. Do – Say Principles Do - Say problem – What we say motivates us and what actually motivates us are often different. When we “say” what motivates us – we rationalize and need to ensure alignment with social norms and self identity (e.g., injunctive vs descriptive norms). “Choice and the decision to take action are separate psychological transactions.” Scott Jeffrey, Ph.D. Group Survey “I would prefer to receive the cash value of the prize rather than the prize itself” Strongly Disagree Strongly Agree 0% 9% 18% 13% 13% 36% Cash Non-Monetary 14% 39% Actual Performance Lift 9%
  11. 11. Framing Principles Choice Architecture – the design of different ways that choices can be made to people and the impact that has on decisions and subsequent behavior (e.g., opt-in versus default behavior). 93% of PhD students registered early when a penalty fee for late registration was emphasized, with only 67% doing so when this was presented as a discount for earlier registration Framing – People react differently to a particular choice or option based on how it is presented (e.g., loss or gain, certainty or uncertain, etc…). Penalty 93% 67% Discount Research: Framing of early registration discount as a penalty or discount?
  12. 12. Fairness Principles Perceived Fairness – people are highly influenced by a sense of fairness (or really perceived lack of fairness). “Fairness seems a bit like air – its absence is a lot more noticeable than its presence.” Mathew Liebermann, PhD Research: Ultimatum Game – 2 players split $10. One person makes offer of split, the other decides if they will accept the offer or reject it (if they accept the money is split as offered, if rejected, no one receives anything). How much do you usually have to offer for the 2nd person to accept? ≥$3 Responder usually rejects offer unless it is over $3 - throwing away money just because they feel slighted and not a fair distribution of funds.
  13. 13. Hedonic Principles Hedonic motivation – hedonic (luxurious) awards are more motivating than equivalent cash or other rewards. These types of awards do not result in “indulgence guilt”, fulfill our desire for pleasure, and are perceived as more valuable than their economic cost.
  14. 14. Unique Fit Principles Idiosyncratic fit – When we feel we have a unique advantage in a program or that a program is tailored specifically to us we are more motivated. This sense of unique fit to us fuels our desire to perform – even if the requirements to achieve success are more difficult. Low cost entry fee MeanJoiningLikelihood(0-10) 6 5 4 3 2 High cost entry fee Likelihood of Joining Credit Card Program Ran Kivetz
  15. 15. Regret Principles Regret Lottery – You feel more pain of loss if you believe you were close to avoiding loss (or had an easy alternative to avoid loss). “…happiness frequently depends not on where we are at the moment, but how easily we perceive we might be elsewhere, or in another, better situation.” Dan Ariely Miss flight due to connection by 45 minutes Misery index - high Miss flight due to connection by 1 minute Misery index – VERY HIGH
  16. 16. Decoy Principles Decoy effect – Preferences for items change when a third option that is asymmetrically dominated (closer to one option than the other) is presented. Research: Economist magazine subscription costs? $59 Digital Only 16% 0% 84% 68% 32% 3 Options $125 Print Only $125 Print & Digital $59 Digital Only $125 Print & Digital 2 Options Dan Ariely Subscription choices for the Economist changed when they added in a third option ($125 print only) compared to when there were only two options. Significantly more people chose the more expensive option – that was closer to the decoy.
  17. 17. Uncertainty Principles Motivating uncertainty effect – Research shows that in many instances, we are more motivated to reach a goal with an uncertain reward than one with a fixed reward. Existing research suggests that we prefer certainty over uncertainty when deciding if we should opt-in for a goal. However, uncertainty is more powerful in boosting motivation en-route to a goal. Research: Drink a large amount of water in two minutes. Some people were told they’d receive two dollars, guaranteed, if they completed the challenge. Others were told they’d receive either one or two dollars, with outcome dictated by a coin toss. $2 43% Completed $2 or $1 70% Completed Shen, Fisbach & Hsee
  18. 18. Self Delusion Principles Positive illusion – People tend to think more positively about themselves than they actually are. We tend to think we are more honest, cooperative, rational, better drivers, and more intelligent than others. Research: When people are asked how good a driver they thought they were, they rate themselves in the 85% percentile (top 15% of all drivers). Only 10% thought that they were below average..
  19. 19. Time Principles Time discounting / Hyperbolic discounting – the idea that present rewards are more desirable than future ones; for example, people often prefer to receive $100 now over $110 in a month’s time. Discounting is non-linear, and its rate is not constant over time – we discount the value of the later reward, by a factor that increases with the length of the delay.. Research: would you want to receive $50 today or $100 next year? How about $50 in three years or $100 in four years? $50 $100 Future $50 $100 Present Today 1 year 4 year 3 year
  20. 20. Size Principles Category size bias – We feel that outcomes are more likely to occur if they are classified with a large category as opposed to a smaller category. We mistakenly believe that items in larger categories have a higher probability of being picked than those in smaller categories. We are also more likely to take action if we think an action is associated with a larger category. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Research: What is the likelihood of picking a grey #8 ball? 8 8 12.9% 18.5% Isaac & Brough
  21. 21. Behavioral Economic Principles Social proof (the bandwagon effect) – Tendency of people to assume the actions of others reflect the correct behavior in a given situation. We look for cues in how others behave and copy their behavior in unknown situations. Status quo or knowledge bias – Tendency of people to choose the option they know best rather than choosing the best option. Sometimes called the IBM effect in business (people would choose the IBM PC because IBM was a well known commodity – although not always the best choice). Zeigarnik effect – Uncompleted tasks are more prevalent in your mind than completed ones. Uncompleted tasks occupy a significantly larger portion of our cognitive attention than do completed tasks (we ruminate about them more).
  22. 22. Behavioral Economic Principles Top dog effect – When powerful people work together on a short- term project, their output (persistence, creativity, agreement) diminishes. Research showed that they tended to focus on who gets to be “top dog” and have the most power. This impact was not replicated in low-power situations. Relative Deprivation Theory – We compare ourselves to those in our immediate circle – not the larger whole, leading high-performing, smart people to feel less so when they are grouped with other high- performing smart people. This tends to decreases confidence, motivation and self-efficacy beliefs.
  23. 23. THANK YOU!For more information, please contact Kurt Nelson, PhD 612-396-6392
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Overview of some key behavioral economic principles - that highlight some of our more irrational tendencies.


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