As a college student who recently moved to a new city on her own, I know what bad financial decisions look like. Although consumer behavior theory may have led me to believe we are always making the best monetary choices to maximize our utility within budget limitations, those textbook chapters could not possibly explain late-night online shopping habits and overvalued Pokémon card collections.
So what possible ways could economists explain these irrational choices with a foundation of perfectly rational graphs and functions?
In 2017, Richard Thaler was awarded a Nobel Prize on this exact topic: explaining why we make such bad decisions. Two years before, the professor published a book titled “Misbehaving: The Making of Behavioral Economics.” Like the title suggests, the book recapped the emergence of behavioral economics by sharing short anecdotes throughout his academic career. The now memoir-like book offers thought-provoking dilemmas in how we value money and at the same time describes surprising empirical findings from decades of studies.
Readers do not need any background in economics to appreciate Thaler’s work — in fact, most examples he brings up can apply to the everyday reader, from deciding on retirement savings to buying baseball game tickets to purchasing new furniture. However, as someone who is in the first few years of studying economics, I especially related to Thaler’s critique and initial confusion when learning the classic economic models of demand and supply.
An economist, an engineer, and a physicist are stranded on an island with a can of food but no can opener. The engineer proposes hitting the can with a rock. The physicist suggests building a fire under it to build up pressure… The economist thinks for a while and says, “Assume that we have a can opener…” Source: Pandalilium
Economists are often mocked for their oversimplified theories; after all, “ceteris paribus” is often the shorthand Latin phrase printed next to every model (meaning “all other [variables] held equal). “Assume we have a can opener” has been a popularized catchphrase to make fun of the ridiculous assumptions economists are forced to infer to simplify models.
Ask any student who has taken an introductory course to economics, including Thaler in the 1960s, and you will find that it’s true. The actual value for these overstated theories of human rationality can be complicated, but it was the opening for Thaler to become one of the first pioneers of the “more practical” behavioral economics field.
One particular dilemma Thaler brought up came from his exploration of how to attach a monetary value to human life. The scenario goes something as follow:
Suppose you have contracted a rare fatal disease with a 1 in 1,000 chance of dying a painless death. There is only one antidote that is sold to the highest bidder. What is the most you are willing to pay to get this antidote?
Researchers are asking for participants in studying this same disease. Participating in the study means you have a 1 in 1,000 chance of getting this (fatal) disease. What is the least amount of money you would demand to take part in the study?
The proposed dilemma inspired me to do a little applied research of my own (meaning I ask everyone I know this question). Almost every respondent demanded more money for increasing their chance of dying vs. paying to reduce their chance of dying. Thaler found the same results, with an average answer of $2000 to $500,000 respectively. In a rational economic theory, the same percent chance of dying should be worth the same, so why does this large difference exist between these two scenarios?
These type of thought experiments are what inspires researchers like Thaler to propose theories that explain how we value things in different scenarios. Prospect theory and the endowment effect are some examples of what came out of the field.
Prospect theory states that we feel the loss more than we feel gain, like how losing $100 hurts more than gaining the same amount. This theory is now often used in business and investing. The endowment effect is how we value an object we already own more than the same object if we did not own it. Like the rare Pokémon cards with crazy high prices listed on eBay — holders may value them that much, but how would they pay the same price to obtain them?
In short, Thaler's book is a fantastic insight into behavioral economics. The fun and creative experiments Thaler proposes are a great way to understand the behind-the-scenes of how a new field emerged and how research in academia is conducted. His engaging narration and honest opinions on the economic field make this a valuable read for non-economists and economists alike.