Beginnings: 1970–78
Economics focuses on optimizations yet it is not necessarily true in every day life
Traditional economics expect people to be well informed, rational and alway optimizing
- People cannot make optimization decision for every decision in life
Endowment effect: people value things they own much higher
SIF: Supposedly Irrelevant Factors
- Example: Endowment effect, sunk costs etc.
Mental Accounting: 1979–85
Transaction utility: humans don’t just think in terms of number and utility maximization but also perceived quality of the deal
- Stores use market price to mark the quality of the goods (increases acquisition utility) but lower the price as a sale therefore increasing transaction utility
Delayed consumption: When we buy something expensive for the future, we think of ourselves as investing rather than expense. When we are actually consuming the product, we feel like it is free
- “Invest now, drink later, spend never”
House Money Effect: When people won money, they think of that money as “house money” and take more risks
- People who won money in stocks perform more aggressive investment, thinking they wouldn’t harm their own money
Break Even Effect: when people are losing but present the chance to break even. They are willing to take larger risks for erasing their losses even though the risk might not be a good idea
Self Control: 1975–88
Economist do not have self control in their theories
- They assume people are perfectly rational and optimize for the future
The current trended economics is to use complicated mathematical models without taking into account of human psychology
People would remove tempting cues to stop themselves from bad behavior (hide the cookie jar) and it cannot be explained by typical economics
Interlude
- Businesses offer bundles to buy at a discounted price in advance (ex. gym membership) because it is sunk cost for the users and purchase decisions are usually made in cold state
Working with Danny: 1984–85
Raising the price when demand is high causes perceived unfairness (uber surges) and decreases reputations
- Only exception is when competitors do the same (airlines fees)
- Business should be careful not sacrifice short term income with long term loyalty
People are willing to lose money to “punish” other humans who they feel are behaving unfairly
Public Good Game: people are willing to enhance public good despite not in their selfish interest
- Ex. donate to charity etc.
- People cooperate, Econs don’t
- When the game is played repeatedly, contributions falls
Most people are “conditional cooperators”: willing to cooperate as long as others are willing to cooperate
Engaging with the Economics Profession: 1986–94
Myopic Loss Aversion: people refuse to take risk once but would would play the game several times and using the law of large numbers to take advantage of the favorable odds
- Learn to weight long term equally as the short term consequence
Narrow framing: a tendency to treat events one at a time rather than as a portfolio
Finance: 1983–2003
Efficient Market Hypothesis:
- You can’t beat the market
- There is no such thing as a free lunch (stock that is definitely going to grow)
Value investing is contrary to this theory
- If everyone in the stock market is rational, there won’t be much trading since no one would buy others’
Noise trader: people who trade based on SIF not genuine news
- People are irrational in the stock market
- High Trading Volumn
- Overreact to news
Investors that try to time market are rarely successful
- It’s much easier to know we are in a bubble than to know when it will pop
Welcome to Chicago: 1995-Present
When a specific number is present, people overemphasize on that specific factors and ignore others
Lying is usually by omission than admission
- Ask for specific details on case of lies
Helping Out: 2004-Present
Automatic is the solution for inertia that blocks people from performing certain action
People enjoy the right to choose, but often can’t make decisions that are best for them
- Libertarian paternalism: advocates nudging people into the right direction
- Nudge: incentivizing Humans to solve their own problems in the right way through certain systems and rules
- ex. Mitigating risks for startups is better than cutting taxes or rates
