Behavioural economics Flashcards
Overconfidence
There is considerable evidence that people show far too much confidence in their own abilities and judgments.
Essentially, this seems to boil down to the fact that people are over- influenced by the strength of particular arguments one way or another and tend to ignore the quantity of evidence supporting particular arguments.
e.g. 50% marriages end in divorce
Why overconfidence?
Many people refuse to put themselves in the failure category and so overestimate their own chances.
However, overconfidence has a (socially) positive effect- many people are driven to succeed against the odds. As a result we end up with; talented artists, dancers, footballers, musicians etc. and great inventions, new ideas etc.
Arguably, if people continually looked at the odds then there would be very little achievement at all.
Social influence
One of the most important influences on our lives is other people. This does not just include family and close friends.
The theory of social proof is an important idea: we see a behaviour as correct in each situation to the degree that we see others using it.
e.g. donations to charity can be increased by the knowledge that other people have contributed.
Why social influence?
In general, the larger the group, the less likely one is to act independently.
One is more likely to conform with members of a group similar to oneself.
The more uncertain one is, the more likely one is to look at other members of the group for guidance.
This leads to perverse results- if no-one knows what to do then this often leads to nothing being done- even in urgent situations! This situation is known as pluralistic ignorance.
Conformity bias
Conformity bias is when our deep-seated need to belong causes us to adapt our behaviours to feel like part of the group. Rather than using personal and ethical judgment, people imitate the behaviour of others in a bid to toe the party line.
e.g. arguably, most fashion fads are the result of such conformity or an attempt to read the rest of the crowd.
Choice Architecture
Thaler and Sunstein (2008) define “choice architecture” as the context in which people make decisions, and a nudge as “any aspect of the choice architecture that alters people’s behavior in a predictable way without forbidding any options or significantly changing their economic incentives.”
Libertarian paternalism
Libertarian paternalism is the idea that it is both possible and legitimate for private and public institutions to affect behavior while also respecting freedom of choice, as well as the implementation of that idea.
Libertarianism
A political philosophy that advocates only minimal state intervention in the free market and the private lives of citizens. It is claimed that pure Libertarianism is not ethical and maybe not possible. There is no neutral frame and so biases will always occur.
Paternalism
The policy or practice on the part of people in authority of restricting the freedom and responsibilities of those subordinate to or otherwise dependent on them in their supposed interest. To miss out the paternalist aspect is to pretend that people always know best- when they patently don’t.
Free-marketeers
Poor choices will be eliminated by the market. However, the market only works well in certain cases where:
i) There are no self- control issues.
ii) The relevant goods are fairly simple to understand.
iii) One enters the market frequently so one can learn from one’s mistakes.
iv) There is feedback so one can learn.
v) We know the product well enough to be able to judge its importance to us.
Free-marketeers exceptions
In all cases there are serious exceptions to these criteria:
i) Markets exploit self- control issues. E.g. in deciding whether to eat less sugary food. Sugary food is widely available. Meanwhile gyms survive financially by exploiting people’s inability to maintain exercise programmes.
ii) Many goods are highly complex e.g. in finance. Even a fairly simple insurance policy has plenty of “small print”.
iii) Many purchases- including the most important- are also the least frequent e.g. buying a house.
iv) Many products simply don’t give meaningful feedback. We rarely find out if our insurance is adequate.
v) Many products are simply unknown to us before we buy it. E.g. juicers produce great fresh fruit juice but the marketers neglected to mention the cleaning involved!
In general, markets will exploit human weakness, especially if there is no profit in not exploiting it.
Changing choice architecture- defaults
Defaults exploit the status quo and loss aversion biases in psychology. People will tend not to do anything- or will actively resist changing when faced with a choice.
There is always a default choice in any system- if someone fails to do something then there is always a consequence even if this is nothing. e.g. if one has a choice between defusing a bomb or not then the default choice is to be blown up.
Defaults are ubiquitous and can be self-serving or helpful:
e.g. the tick box asking whether you want e-mails from a given online firm or not. If it is ticked, then this is the firm self-servingly using the default option to try to fill your email account with emails.
An alternative is a “mandated choice” where one has to tick one alternative to proceed.
This has advantages in that it forces people to think about their choices (e.g. compulsory voting).
However, this ignores the concerns about bounded rationality- maybe people simply don’t have the information or processing power to understand these choices.
A default choice, chosen by a trustworthy person, may be a better way to go.
Changing choice architecture: errors
Humans tend to make mistakes and a good system either compensates for the mistake or is accommodating to that mistake.
e.g. medicine- pills need to be taken at regular intervals or even irregular intervals. Simply giving people a list of instructions and a bottle of pills doesn’t mean that they won’t forget.
For this reason, pills are usually labelled with days of the week etc. to remind you when to take your pills.
Another example: many cars have error-correcting features with warning lights and sounds for leaving the lights on/ door open, handbrake on etc.
Changing choice architecture: feedback
Choices that provide feedback are always useful in encouraging people to make better choices
e. g. Using an ATM machine- when we put a card in the wrong way round.
e. g. Modern laptops have a series of warning systems that continually flash up when e.g. power is about to run out etc. allowing one to take action to avoid it.
Changing choice architecture: understanding
This is the most complex of problems to solve because some products are intrinsically complicated:
One method is to provide a heuristic method of working things out that is easily comprehensible.
e.g. when talking about diet, many government advertisements refer to “five portions” of fruit and vegetables a day as being the minimum one should expect to consume.
