Behavioral Economics: Our Decision-Making is Flawed
This is week two of my behavioral economics crash-course, where I’ll be giving a general overview of a few effects and biases that cause people to act irrationally. There’s so many more, some we’ll get to in later weeks, but these are just a few to get us started.
Endowment Effect
The endowment effect is that people often demand much more to give up an object then they would be willing to pay to acquire it.
An experiment illustrating this effect was performed by Dan Ariely at Duke University. Basketball is an important sport at Duke, and students often wait in line for days, taking turns camping out, in order to get a ticket to the game. Even then, using a lottery system, some students are awarded a ticket, while others are not. Ariely asked those who had gotten a ticket how much they would be willing to sell it for and those who had not gotten a ticket, how much they would be willing to buy one for. The buying price averaged around $200, while the selling price was well above $1000.
Why is it that people value what they own more than other people do? Perhaps they become attached to the memories of the item and, according to Ariely, “fall in love with what they already have.”
The endowment effect can apply to any item large or small. (In my class we used pens, and the effect was still prominent.) A good example to remember this by is garage sales. Many times the selling price for some items is so ridiculously high because the owner is reluctant to part with the item.
Status Quo Bias
The status quo bias is the fact that individuals have a strong tendency to try to keep things the way they are. A good example of this is organ donation. A study was done pairing together countries with similar populations, cultures, and beliefs, the only difference being how consent for organ donation is asked. Half of the countries, including the United States, use a system where people can opt-in, and average around 20% of the population giving consent. The other half of the countries use an opt-out system, and average around 80% consent. Why the difference? Individuals want to put in as little effort as possible into decisions, and will go with the flow.
Framing Effect
The framing effect is one of the most relevant anomalies in our every day lives. Essentially, a person’s response can vary depending on how a situation or question is framed. A basic example of this is when you go food shopping, products are labeled 99% fat free rather than 1% fat.
A better example of this can be seen in the following: Two groups of people were asked to judge a custody battle case. The two parents’ traits are as follows:
Parent A – Parent B
Average income – High income
Average health – Minor health problems
Average work hours – Lots of work-related travel
Reasonably close to child – Very close to child
Routine social life – Very active social life
Half of the participants were asked to which parent would they award sole custody, and 66% responded parent B. The other half of participants were asked to which parent would you deny custody, and 57% chose parent B.
Why is this? Well, the positives or negatives (depending on how the question is worded) stand out against the averages of parent A. Framing techniques are used by advertising, lawyers, and a slew of other ways everyday. It just goes to show that people’s reason-based decision making can be flawed and irrational.
