"Why Psychologists know more about Economic Behaviour than Economists"

1. "Why Psychologists know more about Economic Behaviour than Economists" Peter Ayton Department of Psychology City University

2. "Why Psychologists know more about Economic Behaviour than Economists" The Society for Judgment and Decision Making is an interdisciplinary academic organization dedicated to the study of normative, descriptive, and prescriptive theories of decision. Its members include psychologists, economists, organizational researchers, decision analysts, and other decision researchers.

3. "Why Psychologists know more about Economic Behaviour than Economists" Advice from Members of the The Society for Judgment and Decision Making The Society for Judgment and Decision Making is an interdisciplinary academic organization dedicated to the study of normative, descriptive, and prescriptive theories of decision. Its members include psychologists, economists, organizational researchers, decision analysts, and other decision researchers.

4. "Why Psychologists know more about Economic Behaviour than Economists" Advice from Members of the The Society for Judgment and Decision Making “Cut and run” The Society for Judgment and Decision Making is an interdisciplinary academic organization dedicated to the study of normative, descriptive, and prescriptive theories of decision. Its members include psychologists, economists, organizational researchers, decision analysts, and other decision researchers.

5. "Why Psychologists know more about Economic Behaviour than Economists" Advice from Members of the The Society for Judgment and Decision Making “Cut and run” “Wear a flak jacket” The Society for Judgment and Decision Making is an interdisciplinary academic organization dedicated to the study of normative, descriptive, and prescriptive theories of decision. Its members include psychologists, economists, organizational researchers, decision analysts, and other decision researchers.

6. "Why Psychologists know more about Economic Behaviour than Economists" Advice from Members of the The Society for Judgment and Decision Making “Cut and run” “Wear a flak jacket” “Wear a bullet-proof vest” The Society for Judgment and Decision Making is an interdisciplinary academic organization dedicated to the study of normative, descriptive, and prescriptive theories of decision. Its members include psychologists, economists, organizational researchers, decision analysts, and other decision researchers.

7. "Why Psychologists know more about Economic Behaviour than Economists" Advice from Members of the The Society for Judgment and Decision Making “Cut and run” “Wear a flak jacket” “Wear a bullet-proof vest” “As a backup plan, you could exploit an inadvertent ambiguity in your talk title, and claim that you meant that psychologists know more about economic behaviour than they do about economists.” Indeed, economists are mysterious beings. Many persevere in the belief that people must behave optimally, at least on average, and they seem perpetually baffled by basic psychological phenomena that seem completely intuitive to one's proverbial grandparent. I feel that psychologists indeed understand them quite poorly” The Society for Judgment and Decision Making is an interdisciplinary academic organization dedicated to the study of normative, descriptive, and prescriptive theories of decision. Its members include psychologists, economists, organizational researchers, decision analysts, and other decision researchers.

8. Risky Decisions Q1. Imagine that you face the following pair of concurrent decisions. First examine both decisions and then indicate the options that you prefer. Decision I: Choose between • A sure gain of £2,400 • B. A 25% chance to gain £10,000, and a 75% chance to gain nothing Decision II: Choose between • A sure loss of £7,500 • D. A 75% chance to lose £10,000, and a 25% chance to lose nothing

9. Risky Decisions Q1. Imagine that you face the following pair of concurrent decisions. First examine both decisions and then indicate the options that you prefer. Decision I: Choose between • A sure gain of £2,400 • B. A 25% chance to gain £10,000, and a 75% chance to gain nothing Decision II: Choose between • A sure loss of £7,500 • D. A 75% chance to lose £10,000, and a 25% chance to lose nothing We will consider your choices at the end of the session…

10. "Why Psychologists know more about Economic Behaviour than Economists" Economics and Psychology as Social Sciences. Students of (Classical) Economics will understand economic behaviour in terms of rationality and self interest. Students of psychology will know about Cognitive limitations; Social interaction (trust & fairness); Sensitivity of perception and cognition (i.e. choice) to context.

11. “The economist may attempt to ignore psychology, but it is sheer impossibility for him to ignore human nature... If the economist borrows his conception of man from the psychologist, his constructive work may have some chance of remaining purely economic in character. But if he does not, he will not thereby avoid psychology. Rather, he will force himself to make his own, and it will be bad psychology.” John Maurice Clark, Journal of Political Economy, 1918

12. It seems clear that people cannot conceivably represent all the information that normative models demand we utilise for judgment and choice: “Who could design a brain that could perform the way this model mandates? Every single one of us would have to know and understand everything completely, and at once”. (Daniel Kahneman, 1996).

13. Is the left centre circle bigger? No, they're both the same size

16. Psychological studies of choice show similar context effects.

17. Axioms underlying subjective expected utility theory Transitivity If you prefer A to B and B to C then you should prefer A to C. Intransitive Preference (Tversky, 1969)

18. Flower Flower Depth (mm) Sucrose (µL) A 40 2 B 60 3 C 80 4 D 100 5 Animal Irrationality? Honey Bees violate transitivity in their foraging preferences for flowers. Shafir (1994)

19. Lichtenstein & Slovic’s research payoff payoff $4.00 $16.00 pw = 0.99 pw =0.33 pL = 0.01 pL =0.67 -$1.00 -$ 2.00 B A Which one do you choose? Lichtenstein & Slovic 1971, 1973

20. Lichtenstein & Slovic’s research payoff payoff $4.00 $16.00 pw = 0.99 pw =0.33 pL = 0.01 pL =0.67 -$1.00 -$ 2.00 D C Put a price (in $) on both C and D

21. Lichtenstein & Slovic’s findings payoff payoff About equal EV (~3.945) $4.00 $16.00 pw = 0.99 pw =0.33 pL = 0.01 pL =0.67 -$1.00 -$ 2.00 What did Lichtenstein & Slovic find? P-bet: most Ss choose this $-bet: SS gave higher bids to this Even “within-subjects:” same Subject chooses the P-bet over the $-bet but bids more for the $-bet than for the P-bet.

23. Lichtenstein & Slovic’s findings Two economists, Grether and Plott (1979), realising that: “It suggests that no optimisation principle of any sort lies behind even the simplest of human choices…”(p. 623) conducted a series of studies “designed to discredit the psychologists’ works as applied to Economics” (p. 623). However even after controlling for all the economic explanations of the phenomenon that they could find – including that the experiment be conducted by economists rather than psychologists (“psychologists have the reputation for deceiving subjects” p.629) - the reversals still appeared.

24. Preference Reversals Issue M: Problem: Several Australian mammal species are nearly wiped out by hunters. Intervention: Contribute to a fund to provide safe breeding area for these species. Issue W: Problem: Skin cancer from sun exposure is common among farm workers. Intervention: Support free medical checkups for threatened groups. Largest amount willing to contribute?M>WWhich alternative would rather support?W>M

25. Unsurprising Psychological Finding Often people don’t know what they like or how much they like it

28. Separate versus comparative evaluation

29. 50% 50% Example: Cheeseburgers

30. 30% 60% 10% Example: Cheeseburgers 50% 50%

31. Compromise effect Items can GAIN market share when new options are added to the market when they become the compromise or middle option in the choice set(Simonson 1989) Example: Cheeseburger

32. Context effects on Choice We often don’t know what we want until we see it in some context. What sort of phone do you want? What sort of _____ do you want? What sort of life do you want?

33. Context effects on Choice We often don’t know what we want until we see it in some context. • Introducing an inferior (decoy) item will create a simple comparison with one option and thereby make it appear superior

35. Choice shares Group 1 40% N.A. 60%

36. Choice shares Group 1 Group 2 40% 20% N.A. 0% 60% 80%

37. Attraction effect • The finding that an item can increase the favourable perceptions of similar, but superior, items(Huber et al. 1982)

38. Ariely, D., Loewenstein, G. and Prelec, D. (2003).Coherent arbitrariness: Annoying sounds of 100, 300 and 600 seconds. At the beginning of the experiment, subjects are asked about the last 3 digit number of their social security number. Subjects were then asked whether, hypothetically, they would listen again to the sound they just experienced (for 300 seconds) if they were paid the money amount they had generated from their social security number (e.g. 997=$9.97). In the main part of the experiment, subjects had three opportunities to listen to sounds in exchange for payment.

39. Mean willingness to hear (in dollars) for the three annoying sounds. The data is plotted separately for subjects whose random three digit anchor was below the median (low anchor) and above the median (high anchor). Error bars are based on standard errors.

40. Anchoring affects all sorts of purchases. Simonsohn and Loewenstein (2006) show that movers arriving from more expensive cities in the USA rent more expensive apartments than those arriving from cheaper cities. (after controlling for differences in wealth, taste and information). Anchors – not preferences – determine our choices

41. Real estateagents All real estate agents inspected a house, and were given a 10 page booklet on the house (features, prices of other houses in the area, etc). Also told what the seller thought the house was worth – either high or low. The Agents denied this was relevant – but it affected their judgments. Seller’s estimate Appraisal value Listing price Purchase price Lowest acceptable offer 119,900 114,204 117,745 111,545 111,136 149,900 128,754 130, 981 127, 318 123, 818 10% difference! Northcraft and Neale, 1987

42. Traditional Economics … …assumes that prices of products in the market are determined by a balance between production at each price (supply) and the desires of those with purchasing power at each price (demand ). This assumes that the two forces are independent and together produce the market price. BUT What consumers are willing to pay can easily be manipulated – consumers don’t have a fixed notion of their own preferences and what they are willing to pay. Anchoring shows that the two forces are dependent – prices influence willingness to pay. If the trades we make are arbitrarily influenced by anchors then we may not make choices that reflect the real utility or pleasure we derive from products and the market may not set optimal prices

43. Oct. 9th 2002 Daniel Kahneman receives the Nobel Prize in Economic Sciences Prospect Theory “Daniel Kahneman has integrated insights from psychology into economics, thereby laying the foundation for a new field of research. Kahneman’s main findings concern decision-making under uncertainty, where he has demonstrated how human decisions may systematically depart from those predicted by standard economic theory. Together with Amos Tversky (deceased in 1996), he has formulated prospect theory as an alternative, that better accounts for observed behavior.”

44. Prospect theory • implicit ‘value function’ over changes from ‘r’ • 1. Diminishing marginal sensitivity (concave for gains, convex for losses) • 2. Loss aversion: kink at ‘r’: losses loom larger than gains ‘r’ Kahneman & Tversky, 1979, 1984

45. Samuelson’s Lunch Colleague • Paul Samuelson offered two-to-one odds to his colleague: colleague wins $200 if heads, loses $100 if tails. Colleague refused bet. • Samuelson asked him if he would take 100 such bets. Colleague said yes. • Samuelson offered mathematical proof that his colleague was not rational (from expected utility theory). [Scientia 98:108-13, 1963]

46. Framing You are the CEO of a company faced with a difficult choice. Because of worsening economic conditions, 6000 people will need to be fired to reduce the payroll costs and avoid serious financial problems. Two alternatives programs to combat the firings have been proposed to you. The estimates of the consequences of the programs are as follows:

47. Version A If Program A is adopted, 2000 jobs will be saved. If Program B is adopted, there is a one-third probability that 6000 jobs will be saved, and a two-thirds probability that no jobs will be saved. Which of the two programs would you select? A B

48. Version B If Program A is adopted, 4000 people will be fired. If Program B is adopted, there is a one-third probability that nobody will be fired, and a two-thirds probability that 6000 will be fired. Which of the two programs would you select? A B

49. NYC taxi driversCamerer, Babcock, Loewenstein, & Thaler (2000) heuristic: Set daily income target. Stop working when target is reached. phenomenon: Drivers work least when marginal salaries are highest. Would earn 8% more if they worked same # hours every day. fact: Experienced drivers tend to even out # of hours. Still could do better by shifting work to high demand days.

50. Mental accounting Financial resources fall into distinct accounts or categories that are not completely interchangeable. Decisions are made piecemeal and are influenced by specific context Mental accounts help us regulate our consumption behavior