Behavioral Economics: Crash Course Econ 27

Published on Mar 12, 2016

Why do people buy the stuff they buy? In classical economics, most models assume that consumers behave rationally. As you’ve probably noticed in your real life, in case after case, people don’t actually make rational decisions. There can be emotional or social reasons for all this irrationality, and behavioral economics tries to address this. We’ll talk about risk, nudge theory, prices and perception, and the ultimatum game. So, let’s get irrational, in a logical way, of course.

Behavioral economics

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Behavioral economics

0:00hi this is crash course economics I’m Adrian help and I’m Jacob Clifford one
0:04economist make their models they generally assume that people are
0:07rational and predictable but when we look at actual human beings it turns out
0:11that people are impulsive short-sighted and a lot of times just plain irrational
0:16balloons today were talking about behavioral economics and how people
0:20actually make decisions
0:28behavioral economics is a subfield of economics that focuses on the
0:34psychological social and emotional factors that influence decision-making
0:38that’s not necessarily new fact our old buddy Adam Smith discussed in the theory
0:42of moral sentiments in 1759 but generations of economist chose to ignore
0:46me irrational elements of decision-making since it makes it harder
0:49to predict human behavior but in the last few decades behavioral economics
0:52has made a comeback
0:54several nobel prizes have been awarded to researchers that blood economics and
0:57psychology and behavioral economics has been applied to more and more feel like
1:01marketing finance political science and public policy not important to mention
1:05that irrational human behavior doesn’t negate everything you learned here at
1:08crash course economics just adds another layer of complexity which is exactly let
1:12it crash course in most cases people are rational when the price falls for a
1:16product people have a tendency to buy more that products with a lot of manhole
1:20true but economist also accept that there is bounded rationality limits on
1:24information time abilities might prevent people from seeking out the best
1:28possible outcome for example if the price of ice cream is really low
1:31consumers might not buy more in fact they might buy less if they think that
1:36that low price means that ice cream tastes horrible now if that happens then
1:39la demande doesn’t hold true which creates a serious problem in classical
1:43economics I mean it’s the law of demand you can’t have a situation to break the
1:46law and still caught a lot right that doesn’t happen to other disciplines like
1:49physics accepted that the newtonian laws of physics like gravity hold true most
1:54the time but they break down at the quantum level they explain the orbits of
1:58planets but they have a hard time explaining the orbital electrons and
2:01it’s the same in economics classical economic dearie explain the big picture
2:05stuff pretty well but there’s still a lot of things about individual
2:08decision-making that we just don’t fully understand it and our ice cream example
2:11one of the problems is lack of information
2:14classical economics assumes that consumers have perfect information when
2:18making choices that is they know or at least can quickly access information
2:22about prices and quality but in reality they often don’t sure the consumer can
2:27ask around or call their friends to see if they’ve tried that type of ice cream
2:30but they’re probably not going to do that in this situation consumers may act
2:34on the limited information
2:36have a suspiciously low price which means either the ice cream is a great
2:41deal or it tastes like managed just don’t know
2:44prices do send a lot of signals and there’s even science on how prices
2:48change perception study in California analyzed the brains of people taste
2:52testing a variety of red wines the researchers gave participants fake
2:56prices and scanned their brains to determine the level of enjoyment the
3:01results were surprising when they thought the price was higher than
3:04actually like the one more this held true even when the subjects were given
3:07the exact same wine but we’re told it was a different higher-priced won the
3:12researchers said contrary to the basic assumptions of economics marketing
3:17actions can successfully effect experience pleasantness by manipulating
3:22non intrinsic attributes of goods so once you’ve got a palatable Pinot Noir
3:26you might be able to raise the price and actually raised the demand all you have
3:31to do is change perceptions the idea that perceptions and passions influence
3:36our actions also applies in finance many economist used to believe that assets
3:41like stocks and real estate would stay at or near their real value because cold
3:46calculating investors with by undervalued assets and sell overvalued
3:51assets but that doesn’t explain bubbles in real life
3:55investors aren’t always cold and calculating they can get worked up and
3:58their rationale sometimes this helps explain bubbles from the Dutch tulip
4:02mania of the 17th century to the 2008 financial crisis investors became
4:07irrationally exuberant and we’re driven not by logic but by what economist John
4:12Maynard Keynes once called animal spirit behavioral economics doesn’t blow up
4:17traditional economic theory it just seeks to understand when and why people
4:21behave differently than economic models would suggest let’s go to the thoughtful
4:26one of the most popular experiment to behavioral economics is called the
4:29ultimatum game in this experiment 2 players decide how to share specific sum
4:33of money what’s $100 the first player is given all the money that is asked to
4:37propose a way of splitting it with the second player not the second player
4:40accept the deal both players get to keep the money but the second player refuses
4:45nobody gets keep the money when the first player offers to split the money
4:485050 the second player almost always accepts but what happens when the first
4:52player offers an equal split like a t20 would you accept that offer what turns
4:56out the less equal offers are often rejected that doesn’t seem surprising
4:59that directly contradicts classical economic theory it’s irrational the
5:03rational choice would be for the second player to accept any offer only $1 $1
5:08better than nothing but human behaviour not motivated solely by game it’s also
5:13shape I complex ideas like fairness and justice and even prevent the ultimatum
5:17game shows that people aren’t always as predictable as many economist like to
5:20suggest if people were entirely rational they would consistently make the same
5:24decision given identical options but sometimes people’s preferences are
5:27dependent on how the options presented psychologists call this type of
5:30cognitive bias the friends we would rather eat beef that 75% fat-free or 25%
5:36that would you rather enter a raffle the claims one out of every thousand players
5:39is a winner or a raft the point out that there’s gonna be 909 losers would you
5:44support a lot it’s called the improve our schools act on its name to raise our
5:47taxes act each of these scenarios can be trained in ways that influence your
5:51decision classical economics argues that framing should have relatively little
5:54effect on decision-making because most people are rational intelligent in the
5:58real world people can be pretty irrational thanks so businesses have
6:02known about the psychology of decision making for a long time for example a gym
6:07might break down its membership fee and advertised it only cost a dollar a day
6:10which seems way more affordable than 365 dollars a year and a TV priced at $4.99
6:1799 seems like a better deal than one priced at $500 this is called
6:21psychological pricing it can make people feel like they’re getting a good deal
6:26interestingly high-end retailer sometimes do the opposite
6:29they said their prices at Whole dollars basically signalling their goods are of
6:34a higher quality than you might see at a discount store behavioral economist also
6:38like to talk about something called theory no just encourage people to act a
6:42certain way without actually changing the choices that are available to them
6:46fighting childhood obesity is a priority in many countries and policymakers have
6:50suggested a whole range of solutions everything from banning Sowden schools
6:55to running media
6:56campaigns promoting healthy eating behavioral economist approach the
7:00problem a little differently they wanted to see if they could get children to eat
7:03healthier by rearranging school cafeterias they’ve put healthier foods
7:07like fruits and vegetables on i-label show and less healthy foods like dessert
7:11in less convenient places classical economic theory suggests that this idea
7:16wouldn’t work since rational people would pick the Browns but it turns out
7:20students chose a healthier foods nudge theory works and it’s changing how we
7:25implement public policy there are some issues that can be addressed
7:28best with the right type of nut let’s talk about something else behavioral
7:32economist look at risk
7:34let’s say someone offered you to sealed envelopes one has $100 and one has no
7:38dollars you can choose an envelope or you can take $50 cash right now so do
7:43you take the 50 bucks or what about $49 now this is unlikely to happen to you in
7:48real life but the exercises about your attitude towards risk since there’s a 50
7:5250 chance of getting $100 or nothing
7:55the expected return of the average the possible outcomes is 50 bucks if you’re
7:59willing to accept $50 cash to abandon the envelope than your risk neutral if
8:03you accept less than $50 just to avoid walking away with nothing but your risk
8:08averse behavioral economist have been a lot of studies about risk in particular
8:11loss aversion the idea that people strongly want to avoid losing studies
8:15show that in general losses are more painful than gains are pleasurable to
8:19people might choose a safe course of action even though that’s not the most
8:22logical choice let’s say we flip a coin if its head I give you $100 but if it’s
8:27tales you have to give me fifty dollars now mathematically you should go forward
8:30but many people won’t because they want to avoid losing understanding of loss
8:34aversion can help businesses and policymakers influence decisions for
8:39example some grocery stores in the Washington dc-area trying to decrease
8:44the use of disposable plastic back by offering five cent bonuses if customers
8:49brought reusable bags the policy didn’t do that much later they try to five cent
8:54tax on plastic bags and this time people used fewer disposable bags this is loss
9:01aversion at work
9:02the pain of having to pay $0.05 per bag was greater than the benefit of
9:07receiving five cents per bag
9:08another study analyzed how loss aversion can help incentivize employees
9:12researchers divided workers into three groups the first was a control group
9:17that wasn’t given a bonus the second group was promised a bonus at the end of
9:21the year based on meeting specific goals participants in the third group were
9:25given the bonus at the beginning of the year and we’re told that they would have
9:28to pay it back if they didn’t meet specific goals the workers and the first
9:33and second groups performed about the same but those in the third group
9:37performs significantly better we just hate losing the behavioral economics has
9:42a lot to tell us
9:43accounting for a motion give us a realistic view of how people actually
9:46behaved we might not always be the rational actors classical economist
9:51believe us to be four years economic has had a blind spot but behavioral
9:56economics helps us get a better look how we make decisions thanks for watching
10:00we’ll see you next week thanks for watching crash course economics it’s
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Behavioral Economics: Crash Course Econ 27