Behavioral Economics - History of Economic Thought - Lecture Slides, Slides of Economics

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Behavioral Economics

Main Innovators

• Thorstein Veblen

• John Kenneth Galbraith

• Maurice Allais

• Harry Markowitz

• Daniel Kahneman

• Amos Tversky

• Richard Thaler

Objectives

• Behavioral economics grew out of research

in psychology

• The objective is to modify, supplement, and

enrich economic theory by adding insights

from psychology

• Suggesting that people care about things

standard theory typically ignores, like fairness or

status

• Allowing for the possibility of predictable

mistakes

Methods

• Behavioral economics uses many of the same tools and

frameworks as standard economics

• Assumes individuals have well-defined objectives, that objectives and actions are connected, and actions affect well-being
• Relies on mathematical models
• Subjects theories to careful empirical testing
• An important difference is that BE often relies on experiments

on human subjects

• Behavioral economists tend to use experimental data to test

their theories rather than historical data from the real world

Anchoring: experiment

• 55 subjects were shown a series of six

common products with average retail price of

• For each product, the experiment had three

steps: Each participant was asked

• his/her SSN
• whether he/she would buy the product at a price

equal to the last 2 digits of SSN

• The maximum he/she would be willing to pay

Anchoring: experiment

• Those with higher numbers for the last two

digits of their SSNs bid more

Experiment: Endowment Effect

• Half the participants were given mugs (available at the campus bookstore for $6)
• The other half were allowed to only examine the mugs
• Each student who had a mug was asked to name the lowest sale price
• Each student who did not have a mug was asked to name the highest purchase price
• Supply and demand curves were constructed and the equilibrium price was obtained
• Trade followed
• There were four rounds of this

Bias Toward the Status Quo:

Default Effect

• When confronted with many alternatives, people sometimes avoid making a choice and end up with the option that is assigned as a default
• Example: Experiment showing that more subjects kept $1. participation fee rather than trading it for a more valuable prize when the list of prizes to choose from was lengthened
• Possible explanation is that psychological costs of decision- making rise as number of alternatives rises, increasing number of people who accept the default
• Retirement saving example illustrates the default effect when the stakes are high

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The Problem of Dynamic Inconsistency

• People often waste expensive gym

memberships

• The LIU gym plan for faculty

Choosing Movies

• Subjects given opportunity to choose a movie

video from a set of 24 titles

• Four Weddings and a Funeral
• Schindler’s List

• When choosing for today: 56% choose low-brow

• When choosing for next Monday, 37% choose

low-brow

• When choosing for second Monday, 29% choose

low-brow