Misbehaving (preface - chapter 12) SAQs

what is the difference between Humans and Econs?

• Econs represent the ideal person under traditional economics. They are an individual that makes the most optimal decisions based on their cirumstances void of any bias.

• Humans are people that make economic decisions on the basis of their biases, human-tendencies, and passions. Thaler mentions in the book that Econs are following the optimization-model, however humans operate in a way that counteracts that model, and instead operate based on their emotions. Humans let their current state affect their economic choices such as being hungry while shopping making them buy more things. Giving

what is the difference between normative and descriptive theories?

• Normative Theory

  • This type of theory focuses on what the most optimal behavior pattern of a person should be. Within economic theory, this would lean more toward the behavior of an econ rather than a human

• Descriptive Theory

  • This type of theory places more of an emphasis on the way people actually behave rather than their most optimal choices. It is more of an emphasis on the human aspect, commonly focuses on within behavioral economics.

what are supposedly irrelevant factors (SIFs), and how does the fact that they often are not irrelevant pose problems for traditional economic theory? what are some examples of SIFs?

• SIFs refer to everything that distinguished humans from Econs. Every human behavior and decision that would be considered “irrational” by a traditional economists perspective would be considered an SIF. This poses issues with traditional economic theory because that whole theory revolves around a hypothetical human being that is void of any bias or irrational decision making. If every traditional economic model bases it’s foundation on that hypothetical robot of a human being then it will lead to inaccuracies and unpredictable behavior. An example of this could be our sunk cost mindset, endowment effects, and our sensitivity to change.

Why does diminishing marginal utility of wealth predict risk aversion?

• Diminishing marginal utility shows a decreasing rate of appreciation for wealth as you gain more of it. The reason this predicts risk aversion is because the pleasure of receiving a certain amount of money is much smaller than had you lost that same amount.

What is the “as if” critique from traditional economics?

What is a preference reversal, and why do they pose a problem for traditional economic models?

Traditional economic model hinges on the idea that people have “well-defined preferences” as to say that people will always prefer one thing over the other. This is proved to not be the case when two economists run an experiments where people showed a habit of having “preference reversals”, which is the say that they preferred choice A to choice B AND showed an additional preference of choice B to choice A.

Traditional economists often say that if the stakes are high enough people will respond rationally. How is this criticism incompatible with the argument that learning is also important for rational responding?

• The reason learning is not compatible with the high stakes argument is because it does not take into account how often we get to learn from high stakes decisions. Things such as buying a car, leasing an apartments, buying a house are decisions that we do not make that often but that also inversely scales with the stakes. High stakes decisions are made less often, therefore we are given less chances to learn from those experiences. How could you learn from an experience that you only get to have once.

Why does having sales tend to make consumers happier than instead having an “everyday low pricing” strategy?

• The amount of satisfaction that an individual derives from a purchase all hinges on their transaction utility, in other words the perceived quality of the deal. In an “everyday low pricing” strategy there is an inherent lower transaction utility compared to a “sale” that a store is having because it feels like you are getting a better deal.

what is a sunk cost?

• this refers to a cost that has already been incurred and cannot be recovered. We often mistakenly make irrational decisions on the basis of a past mistake. Thaler uses the example of the mother who wants to force her daughter to wear dresses she bought previously. In this instance, the sunk cost would be the dresses since the money has already been spent. The mother’s attitude of wanting the daughter to wear the dresses, in spite of her wishes represents the psychological aspect of the sunk cost fallacy in which we feel the need to invest more of time, effort, or money in to something because of what has already been invested rather than just stopping.

what contributed to people no longer paying off their home mortgages as quickly as possible and being reluctant to having mortgage debt?

The long term decline in interest rates and emergence of mortgage brokers. Mortgage brokers broke the norm of paying for mortgages early on and made refinancing easier. In regards to debt, the rise in home equity drove up consumption for other things like cars, then house prices dropped and car prices dropped so it is hard to finance the mortgage.

The Reagan-era tax reform contributed to people stopping paying off their home mortgages as quickly as possible and being reluctant to have mortgage debt as it made tax deduction exclusive to the paid home mortgage interest. This is because the tax reform created an economic incentive for banks to create home equity lines of credit that households could use to borrow money in a tax-deductible way. This made it more appealing for homeowners to take on mortgage debt and to use their home equity to finance other purchases, such as a car or home improvements.

why are people risk seeking for losses?

• The reason people are risk seeking for losses is due to the “loss aversion” covered within prospect theory.

what is a principal-agent model, and how does this relate to Thaler’s planner and doer model?

• A "principal-agent model" describes a situation where one party (the "principal") delegates decision-making power to another party (the "agent") to act on their behalf, often leading to potential conflicts of interest; in Thaler's "planner-doer" model, the "planner" represents the principal, acting as the long-term decision-maker, while the "doer" is the agent, making immediate choices that may not align with the planner's long-term goals, creating an internal conflict similar to a principal-agent problem

why are systematic errors/biases in judgement more of a problem for traditional economic models than random errors/biases in judgement?

The long term decline in interest rates and emergence of mortgage brokers. Mortgage brokers broke the norm of paying for mortgages early on and made refinancing easier. In regards to debt, the rise in home equity drove up consumption for other things like cars, then house prices dropped and car prices dropped so it is hard to finance the mortgage.

The Reagan-era tax reform contributed to people stopping paying off their home mortgages as quickly as possible and being reluctant to have mortgage debt as it made tax deduction exclusive to the paid home mortgage interest. This is because the tax reform created an economic incentive for banks to create home equity lines of credit that households could use to borrow money in a tax-deductible way. This made it more appealing for homeowners to take on mortgage debt and to use their home equity to finance other purchases, such as a car or home improvements.