Value Investing

Unless You Are Spock, Irrelevant Things Matter in Behavioral Economics

By Richard Thaler, Misbehaving: The Making of Behavioral Economics

Early in my teaching career I managed to get most of the students in my class mad at me. A midterm exam caused the problem.

I wanted the exam to sort out the stars, the average Joes and the duds, so it had to be hard and have a wide dispersion of scores. I succeeded in writing such an exam, but when the students got their results they were in an uproar. Their principal complaint was that the average score was only 72 points out of 100.

What was odd about this reaction was that I had already explained that the average numerical score on the exam had absolutely no effect on the distribution of letter grades. We employed a curve in which the average grade was a B+, and only a tiny number of students received grades below a C. I told the class this, but it had no effect on the students’ mood. They still hated my exam, and they were none too happy with me either. As a young professor worried about keeping my job, I wasn’t sure what to do.

Finally, an idea occurred to me. On the next exam, I raised the points available for a perfect score to 137. This exam turned out to be harder than the first. Students got only 70 percent of the answers right but the average numerical score was 96 points. The students were delighted!

I chose 137 as a maximum score for two reasons. First, it produced an average well into the 90s, and some students scored above 100, generating a reaction approaching ecstasy. Second, because dividing by 137 is not easy to do in your head, I figured that most students wouldn’t convert their scores into percentages.

Striving for full disclosure, in subsequent years I included this statement in my course syllabus: “Exams will have a total of 137 points rather than the usual 100. This scoring system has no effect on the grade you get in the course, but it seems to make you happier.” And, indeed, after I made that change, I never got a complaint that my exams were too hard.

RICHARD H. THALER is a the author of “Misbehaving: The Making of Behavioral Economics,” from which this article is adapted, and which will be published this month by W.W. Norton, see full article here and more on the book below

Richard H. Thaler has spent his career studying the radical notion that the central agents in the economy are humans?predictable, error-prone individuals.Misbehaving: The Making of Behavioral Economics is his arresting, frequently hilarious account of the struggle to bring an academic discipline back down to earth?and change the way we think about economics, ourselves, and our world.

Traditional economics assumes rational actors. Early in his research, Thaler realized these Spock-like automatons were nothing like real people. Whether buying a clock radio, selling basketball tickets, or applying for a mortgage, we all succumb to biases and make decisions that deviate from the standards of rationality assumed by economists. In other words, we misbehave. More importantly, our misbehavior has serious consequences. Dismissed at first by economists as an amusing sideshow, the study of human miscalculations and their effects on markets now drives efforts to make better decisions in our lives, our businesses, and our governments.

Coupling recent discoveries in human psychology with a practical understanding of incentives and market behavior, Thaler enlightens readers about how to make smarter decisions in an increasingly mystifying world. He reveals how behavioral economic analysis opens up new ways to look at everything from household finance to assigning faculty offices in a new building, to TV game shows, the NFL draft, and businesses like Uber.

Laced with antic stories of Thaler’s spirited battles with the bastions of traditional economic thinking,Misbehaving is a singular look into profound human foibles. When economics meets psychology, the implications for individuals, managers, and policy makers are both profound and entertaining.

Review

“The creative genius who invented the field of behavioral economics is also a master storyteller and a very funny man. All these talents are on display in this wonderful book.” (Daniel Kahneman, winner of the Nobel Prize in Economics and author of Thinking, Fast and Slow)“Misbehaving: The Making of Behavioral Economics gives us the story behind some of the most important insights in modern economics. If I had to be trapped in an elevator with any contemporary intellectual, I’d pick Richard Thaler.” (Malcolm Gladwell)

“Richard Thaler has been at the center of the most important revolution to happen in economics in the last thirty years. In this captivating book, he lays out the evidence for behavioral economics and explains why there was so much resistance to it. Read Misbehaving. There is no better guide to this new and exciting economics.” (Robert J. Shiller, winner of the Nobel Prize in Economics and author of Finance and the Good Society)

“I would like everyone in business to buy this book and claim half the cost on expenses. The book is so enjoyable, it would be improper to claim more.” (Rory Sutherland, vice-chairman, Ogilvy & Mather UK)

“Richard Thaler not only founded behavioral economics, he’s also a great storyteller and observational comic. Have a seat, pour some good wine, and listen as the founder of a field narrates the fight to force economists to acknowledge the human brain.” (Chip Heath, Stanford University, co-author of Made to Stick, Switch, and Decisive)

About the Author

Richard H. Thaler is the coauthor of the best-selling book Nudge with Cass R. Sunstein, and the author of Quasi Rational Economics and The Winner’s Curse. He is a professor of behavioral science and economics at the University of Chicago Booth School of Business and, in 2015, the president of the American Economic Association.
Unless You Are Spock, Irrelevant Things Matter in Behavioral Economics