I admit, I’m a big fan of behavioral economics.
Located at the not so popular nexus of psychology and economics, behavioral economics seeks to understand how and why humans make economic decisions In spite of its dry name and description, the findings of behavioral economics are stunning and humbling.
While capable of amazing leaps of creativity and ingenuity humans are surprisingly irrational when making economic decisions. Behavioral economics codifies these seemly aberrant behaviors into decision heuristics. It turns out we rely heavily on these subconscious “rules of thumb” to make decisions every day. And that’s generally a good thing. We are bombarded with decisions everyday and can’t possibly take the time to evaluate each one consciously. For the most part this strategy works well. Where it gets really interesting are the points where these heuristic strategies cause us to behave irrationally.
For example we look for easy comparisons: given three vacation choice, two to Rome and one Paris, we pick the nominally better of the two Rome trips and ignore the Paris option even if the Paris trip a better value than the Rome trip. Remove the lessor Rome option and Paris and Rome perform equally. Or, when forced to make selections in advance, say lunch for the next several weeks, we select for high diversity. However, if given the choice each day we’re likely pick from just a few items (perhaps just one).
Even more interesting is how easily we are effected by innocuous factors, tiny cues (priming) can have enormous impacts. In one of the more amazing priming studies, research participants are asked to write down the last two digits of their social security number on the sheet prior to placing their bids for a variety of products being offered for sales. Participants with numbers higher than 70 bid 30-percent more on average than participants given numbers below 30. Or consider that fact that we’ll pay more for life insurance in case of a terrorist attack while traveling to Europe than a simple comprehensive plan. By placing a specific death scenario, terrorist attack in Europe, in the buyers mind they pay more for less, even if comprehensive life insurance includes terror, sharks, etc.
A book I’m currently reading (Antifragile by Nissim Taleb) posits, among many ideas, that practice generally predates scholarly discovery. So, for example, human beings invented the bow and arrow out necessity thousands of years before science would explain mathematically how gravity and trajectory work. Behavioral economics follows this example in that its core findings have largely been understood and exploited by magicians, advertisers, marketers and sales people for decades and in some cases centuries. That doesn’t change the fact that human irrationality is fascinating and a little disappointing.