Friday, November 6, 2020

Review of Misbehaving: The Making of Behavioral Economics by Richard H. Thaler

This review was written by Eugene Kernes

Book can be found in:
Genre = Economics, Behavioral
Intriguing Connections = Learning Economics: Basic to Advanced

Elaborate Description

The purpose of behavior economics is to add other disciplines to the study of economics, principally psychology. Economics carried more weight in influencing policy than other social sciences. Thaler started to notice more and more behaviors that people do which contradict the basic assumptions. Starting a list of observation which seemed to go against what a supposed rational agent would do was the germinal stage of behavioral economics. Behavioral economics would not have been possible if not for the collaboration of psychologists Daniel Kahneman and Amos Tversky who devised Prospect theory which Thaler noticed answered many of the lists’ problems. Prospect theory shows that gains have a smaller absolute impact than the same amount of loss. People feel loss more than gain. It was with conversations and research of Kahneman and Tversky which enabled the development of behavioral economics.

Initial research showed what become known as endowment effect, that people value what they own more highly than things they do not own. Before obtaining something, people value an object less than when they own it while when they have ownership will no longer sell it at the price for which they would not have purchased it. What followed is broadly considered mental accounting. Money is easiest traded asset and can be used for any purpose, but people have different budgets for certain expenses and will not move money to where it is more needed even if another budget is not being used much. Thaler claims that the idea of a sunk cost is important in economics but is not taken up as often as it should. Even though a person cannot regain the cost, the person will try to utilize the product bought even though time could be spent doing more beneficial activities.

Economics uses mostly acquisition utility, generally referred to consumer surplus which is the difference in value between what is bought and given up. Thaler finds that transactional utility is extremely important which is the price difference between what would normally be paid and what was actually paid. Anchoring a price and then the adjusting to it as a sale or an additional cost has vast differences to what is being purchased.

Self-control and other research showed that people did not really do what the rational agent is supposed to do. The economics community did have similar reasons why not to accept the results such ‘as if’ argument that people did not really need to solve related equations to behave appropriately, they just needed to act as if they were choosing based on the complex equations. Another argument was that people would have an incentive to do better with higher monetary or other values. Economists also argued that people will learn over time to make the correct decisions. The final usual argument about the results was that competition would force competitors to maximize their decisions. These four arguments against the results of the anomalies that Thaler found stand as contradictory. As if creates unrealistic assumptions, there is no research on incentives working for only large-scale problems, learning requires repetition which life provides a limited amount of, and business do not maximize.

Thaler shows many discrepancies between what people choose and what is predicted by rational choice model. Rational choice creates a narrow choice of behavior that can be considered rational. When Thaler provides evidence that people can do better, he also creates a narrow choice that would be acceptable. The traditional models lack much variables and Thaler does much to show which variable are missing, but the claims are also limited. At times there seems to be paradoxical reasoning such as in one chapter making a claim that there are not enough trades to adhere with rational choice model, but in another chapter making a claim that there are too many trades to adhere with rational choice model. The biggest problem with the book is what it lacks: negative consequences. Thaler does acknowledge that nudging people can have very bad consequences but is briefly mentioned and not given proper explanation.

Behavior economics is important in the fact that it shows how much economics there is still out there to understand and creating interdisciplinary understandings. It takes more than just economics to know which economic models can stand to application. Applications are not by necessary financial as the latter part of this book explores but also social applications. There is a huge contrast in the difference between what a rational agent perceives as fair and what is considered fair by a community. This book has more than just theories and ideas, it is also part autobiography which consists with research.

Book Details

Edition ISBN:  9780393352795
Pages to read:   360
Publication:     2016
1st Edition:      2015
Format:            Paperback

Ratings out of 5:
Readability    5
Content          4
Overall           4