Lecture 2: history of economic psychology

Question 1

Psychological principles

Answer 1

1. many choices are automatic
2. people are social animals
3. people respond to mental models
4. people are hard to mobilize
5. small changes can have big effects

Question 2

Cobra effect

Answer 2

Brits wanted to reduce cobra’s in India so they gave a bounty for every cobra skin, but people startes making more cobras and skinning them to make money. So when the brits found out the cobra’s were released and they ended up with even more cobra’s.

rewards and punishments may be counterproductive

Question 3

Gneezy and Rustichini, 2000

Answer 3

fines for picking up children late from daycare. Number of times people were late increased, because they now had an excuse for being late.

rewards and punishments may be counterproductive

Question 4

why should you always test your intervention before using it?

Answer 4

because it can lead to different behavioral outcomes than expected;
- cobra effect
- daycare
- teenage moms (dolls)

Question 5

Adam Smith

Answer 5

economy started with him when he wrote “wealth of nations” in 1776. before that he wrote moral sentiments.

Question 6

wealth of nations 1776

Answer 6

Book about organization of society. Smith believed in rational economic man with self-interest and the invisible hand.

by Adam Smith

Question 7

Moral sentiments 1759

Answer 7

says the opposite of what he later wrote in wealth of nations. talks about how it can make people happy to see others happy so they do things not for their own benefit, but for others (social utility). He proposes empathy-induced altruism

by Adam Smith

Question 8

Blaise pascal

Answer 8

Mathematician (1623-1662), came up with expected value.

Question 9

Expected value

Answer 9

EV = pX

Question 10

St. Petersburg paradox and utility

Answer 10

about why people gamble. People accept risks based on the possible losses or gains and the utility.
gamble: throwing a coin and playing until you throw tails, heads doubles the money you win.
- how much money would you pay to play this game?
based on EV this amount should be infinite.

by Daniel and Nicolas Bernoulli

Question 11

Jeremy Bentham (1748-1832)

Answer 11

wrote about organization of society, came up with the principle of hedonic calculus.
the sum of hedons and dolors would help us make a decision. in order to use this to maximize we should quantify and compare pleasure of possible acts.

Question 12

hedons and dolors

Answer 12

• hedons = unit of pleasure
• Dolors = unit of pain

Question 13

John Stuart Mill (1806-1873)

Answer 13

greatest happiness principle (utility) = actions are right if they proportionally promote happiness and wrong if they produce the opposite of pleasure

Question 14

Carl menger (1840-1921)

Answer 14

founder of Austrian school of economics and developed a more complicated version of Maslows pyramid of hierarchy (before Maslow)
= hierarchy of motives

Question 15

John Maurice Clark (1884-1963)

Answer 15

wrote two articles
- economics and modern psychology 1
- economics and modern psychology 2

about how the two principled influenced eachother and the point where they went different ways.
- economics became mathematical (f-twist)
- Psychology became experimental

Question 16

George Katona (1901-1981)

Answer 16

indes of consumer sentiments; predictor of how the economy develops.
asks people if they plan to spend money on a big purchase in the upcoming weeks. individual choice determines what happens with the economy, because they add up.

consumentenvertrouwen vs consumentenuitgaven

prototypical economic psychologist

Question 17

Ward Edwards (1927-2005)

Answer 17

brought economy and psychology back together after the diversion.

Question 18

Herbert Simon

Answer 18

• bounded rationality: economy assumes rationality, but we know from psychology that people have limited cognitive capacity.
  people are motivated to be rational within the limit of their cognition
• satisfycing: people choose something that is “goof enough” but maybe not the best and will switch when something better comes along.

nobel prize winner in 1978

Question 19

Daniel Kahneman

Answer 19

researched probabilities and risk judgement (how people decide p).
people use heuristics and biases for this.

nobel prize in 2002

Question 20

Richard H. Thaler

Answer 20

• mental accounting: we have mental systems that keep track of our finances
• fairness doesn’t exist in economics, but it does in humans.

nobel prize in 2017

Question 21

Assumptions of economic theory

Answer 21

• stable preferences
• self interest
• maximization (greed)
• no cognitive limitations
• unlimited will-power
• complete information (market transparancy and assymetrical information)
• long time perspective

Question 22

Carmerer & Loewenstein

Answer 22

looking at the assumptions of economic theory and determining if they are true or not can give better insight for predictions and policy making.

Question 23

People may not be rational, but they act rationally

economists’ arguments vs psychological rebuttals

Answer 23

there are many instances of irrational behavior

Question 24

irrational agents will become extinct

economists’ arguments vs psychological rebuttals

Answer 24

if you don’t know your preferences incentives will influence you and every time this happens when someone sells you something there is a money pump

Question 25

aggregate behavior is more rational (errors in rational behavior cancel out)

economists’ arguments vs psychological rebuttals

Answer 25

there are systematic deviations where people don’t act rational

Question 26

ii

in the real world people will get it right (experiments differ from the real world)

economists’ arguments vs psychological rebuttals

Answer 26

systematic deviations and overconfidence (restaurant?)

Question 27

If the stakes are high enough, people will get it right

economists’ arguments vs psychological rebuttals

Answer 27

small money decisions add up (and are relevant for everyday decisions)

Question 28

rationality

Answer 28

when people decide what to do, they look at what it gives them and how likely they are to get it.

Question 29

Where does rationality fail on the likelihood of gain side?

Answer 29

• biased propability estimates = people can’t estimate p
• availability heuristics = how often instances come to mind (terrorist attacks versus drowning news coverage)
• cognitive heuristics = rules of thumb for a probability or frequence estimate
• representativeness heuristics and the base-rate fallacy = philosophy students

Question 30

Where does rationality fail on the gain side

Answer 30

• salary: people like to go up in salary
• bronze winners are happier than silver
• people that win the lottery and people that become paraplegic after a car accident return to the same level of happines after time