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The Top 5 Behavioural Principles That Could Potentially Save Your Life. Nattavudh Powdthavee LSE and The University of Melbourne. Economics is changing. Have you ever wondered why. ...good men (and women) sometimes cheat,. ...and politicians lie?.
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The Top 5 Behavioural Principles That Could Potentially Save Your Life Nattavudh Powdthavee LSE and The University of Melbourne
Have you also ever wondered why it’s hard to get out of a bad relationship,
What about why we can’t seem to agree to disagree, and why is it that we often view people who are disagreeing with us as evil, compared to us who are righteous?
And, finally, why can’t I seem to find a girlfriend/boyfriend?! But first, let me talk a little bit about why we are here today…
More formally Economicsis a social science concerned with the efficient allocation of scarce resources
But perhaps the time has come to think differently – and to define economics differently.
An alternative definition for 2012: Economicsis a social science concerned with the best way to allocate plentiful resources to maximize a society’s well-being and mental health.
The problem is that we are absolutely terrible at knowing what is good for us!And most of us are systematically making this same mistake over and over again...
Behavioural Principal #1“We hate losing more than we love winning”More formally, loss aversion, prospect theory, endowment effect, and status quo bias
Raise your hands if you’ve ever… … kept a gym membership even though you don’t go as often as you should? … bought a movie ticket and then find out just a few minutes in that it’s the worst film you’ve ever seen, but then you continued sitting there watching uncomfortably until the end? … stayed in a bad relationship longer than you would have liked? … kept a lot of junk things in your home?
Preferences over risk Economists generally assume that risk preferences are stable across decision contexts If somebody is risk averse, he’s always risk averse in any given situation
But let us consider the following two gambles • Given a choice between winning $10,000 or risk a 50% chance of winning $25,000 or winning nothing, which one would you choose? • Given a choice between losing $10,000 or risk a 50% chance of losing $25,000 or losing nothing, which one would you choose?
How we make decisions • Economists tell us that we should always calculate the expected utility of each of our choice before making any decisions • Here, it is either $10,000 or $25,000*0.5 = $12,500 • The absolute value of loss and gain from the gamble is the same at $12,500 (so we should be risk-seeking in the 1st, and risk-averse in the 2nd)
The next slide shows a diagram that could potentially save your life!
Key point: Losing is not the direct opposite of winning (at least in terms of its absolute effect) Why on earth is that?!?!
A simple answer to why we are ‘averse to losses’ is that because of the evolutionary process Organisms that treat threats as more urgent than opportunities have a better chance to survive and reproduce
Three doors; one has car behind it The other two have goats...
Three doors; one has car behind it The other two have goats...
Three doors; one has car behind it The other two have goats...
Now I am going to give you a chance to ‘switch’ door from the door you picked to the other unopened doorWould you change your mind and switch doors?
If you’re like most people (in fact, over 90% of the general population), then you would not switch doors
What you probably don’t know, however, is that by switching doors, your probability of winning a car increases from 33% to 66%*... *I will come back to this at the end of the talk if we have time (but you may need to remind me)
A key idea here is that most people think that they will regret making foolish actions more than foolish inactions
Is that why we like to remain miserable than risk being happy? A key word here is reference point To give you an example, consider the following choices handed to you by your boss Choice A: a raise of $10,000 OR Choice B: 20 extra days of vacation Which one would you prefer?
On average, the proportion of people preferring one over the other is probably the same at 50:50 But what about this one?
Now consider the following choices Choice A: no gain and no loss OR Choice B: a raise of $10,000 but 20 days less of vacation Which one would you prefer?
People’s taste is not fixed; they actually vary significantly by reference point
Is this is why people often fail to agree to disagree? • Since losses hurt so much more than the joy we get from gains, everybody hates losing more than admitting defeats • This is why people who are very loss averse often turn down very favorable opportunities
So when is loss aversion good? • Here represents the rates of organ donations by European countries
In Denmark, Netherlands, UK, and Germany, people are asked: “If you want to donate your organs, please tick the box” In Austria, Belgium, France, Hungary, Poland, Portugal, and Sweden: “If you do not want to donate your organs, please tick the box”
The (401k) Saving Plan • Employees who do not join a pension plan tends to save less than the predicted life-cycle. • The 401k ‘opt-out’ pension plan which asks people to commit in advance to saving leads to an increase in the average saving rate from 3.5% to 13.6% over the course of 40 months. • This is the power of the ‘default’ option
Word of adviceEliminate losses when thinking about important decisions (if I break up this miserable relationship now, I would never find anyone who might love me again).Instead, think about how we could gain from such an opportunity (I’m single again, yippee!)
Behavioural Principal #2“We tend to overreact to rare events that defy our expectations”More formally, theory-induced blindness, gambler’s fallacy, hot hand fallacy, the black swan theory
A few months back... • My coauthor and I became unexpectedly famous because of this:
No, we didn’t break the world record for the number of correct guesses of coin flips …which incidentally is 19 by the way
Pretty laughable, right? • But it really is no different to this…
