1) Supposedly irrelevant factors (SIFs)
Score 72/100 vs. 96/137
world of Humans! Economy needs injections of psychology.
Randomized control experiments
Naturally occurring experiments
not always optimize models take SIFs into account!
= unimportant to Econs, important for Humans.
2) The Endowment effect
Thesis: ‘the value of a life’
Identified life > statistical life (Econs: no preference)
Trade off: money and dead: fatal disease
o Willingness to pay << Willingness to accept
Wine: opportunity costs! (Richard Rosett)
Discount >> surcharge: framing!
ENDOWMENT EFFECT: paying is taking money out of your pocket, not receiving is a mere
opportunity cost.
Value things that are already part of our endowment higher.
3) The list (shh)
List of behavioral inconsistent with rational choice:
Not ignore sunk costs
Hindsight bias
Heuristics to simplify thinking (ex. Dhruv)
Econs: errors cancel each other out
Humans: the errors are not random!!!
4) Value theory (= prospect theory)
Rational people use normative and descriptive theories to think about a problem (ex. Pythagoras)
But human decision making is not normative and descriptive: decision making under uncertainty!
, Initial ideas: Bernouilli: utility function
o Risk aversion
o Diminishing sensitivity
Expected utility theory: von Neuman & Morgenstern right way to make decisions
Kahneman & Tversky: offer a prediction of the actual choices humans make.
The value function: focus changed from levels of wealth to changes in wealth.
*Because people think in terms of changes, not levels.
Upper portion: utility of wealth function
Loss function: also diminishing sensitivity to changes (Weber-Fechner, ex. Car bulbs), each
loss gets increasingly painful risk-averse for gains, risk-seeking for losses (‘pain/gain of
losing the second $100) loss aversion
5) California dreamin’ (OTC)
Working on his thesis in California with Sherwin Rosen @NBER: national bureau of Economic
Research
Oregon: meet psychologists that inspired R
Kahneman & Tversky asked each other and some students hypothetical questions: actual
experiments were hard. but Econs care about what people do and not what they say they do.
* R started to use hypothetical questions
Tucson: visit Adam Smith: tokens with induced value = created market ( R: you decide yourself
how much you are willing to pay for something!)
Caltech: Charlie Plott tested what happened when the rules of market change: not in a lab
R wanted to study behavior and remain open-minded about the techniques he would use! Just
use the method that seemed the best.
Cornell
6) The Gauntlet
= List of reasons why economists could ignore some behaviors: talking about it, felt like running a
medieval gauntlet R provided answers to these putdowns from Econs
People act as if they follow the rational models.
At high stakes stuff would get right.
o A>B & B>A; risky thing more expensive
People learn from their mistakes
o Not with high stakes (not often)
Invisible handwave
o Markets cannot make you rational
Score 72/100 vs. 96/137
world of Humans! Economy needs injections of psychology.
Randomized control experiments
Naturally occurring experiments
not always optimize models take SIFs into account!
= unimportant to Econs, important for Humans.
2) The Endowment effect
Thesis: ‘the value of a life’
Identified life > statistical life (Econs: no preference)
Trade off: money and dead: fatal disease
o Willingness to pay << Willingness to accept
Wine: opportunity costs! (Richard Rosett)
Discount >> surcharge: framing!
ENDOWMENT EFFECT: paying is taking money out of your pocket, not receiving is a mere
opportunity cost.
Value things that are already part of our endowment higher.
3) The list (shh)
List of behavioral inconsistent with rational choice:
Not ignore sunk costs
Hindsight bias
Heuristics to simplify thinking (ex. Dhruv)
Econs: errors cancel each other out
Humans: the errors are not random!!!
4) Value theory (= prospect theory)
Rational people use normative and descriptive theories to think about a problem (ex. Pythagoras)
But human decision making is not normative and descriptive: decision making under uncertainty!
, Initial ideas: Bernouilli: utility function
o Risk aversion
o Diminishing sensitivity
Expected utility theory: von Neuman & Morgenstern right way to make decisions
Kahneman & Tversky: offer a prediction of the actual choices humans make.
The value function: focus changed from levels of wealth to changes in wealth.
*Because people think in terms of changes, not levels.
Upper portion: utility of wealth function
Loss function: also diminishing sensitivity to changes (Weber-Fechner, ex. Car bulbs), each
loss gets increasingly painful risk-averse for gains, risk-seeking for losses (‘pain/gain of
losing the second $100) loss aversion
5) California dreamin’ (OTC)
Working on his thesis in California with Sherwin Rosen @NBER: national bureau of Economic
Research
Oregon: meet psychologists that inspired R
Kahneman & Tversky asked each other and some students hypothetical questions: actual
experiments were hard. but Econs care about what people do and not what they say they do.
* R started to use hypothetical questions
Tucson: visit Adam Smith: tokens with induced value = created market ( R: you decide yourself
how much you are willing to pay for something!)
Caltech: Charlie Plott tested what happened when the rules of market change: not in a lab
R wanted to study behavior and remain open-minded about the techniques he would use! Just
use the method that seemed the best.
Cornell
6) The Gauntlet
= List of reasons why economists could ignore some behaviors: talking about it, felt like running a
medieval gauntlet R provided answers to these putdowns from Econs
People act as if they follow the rational models.
At high stakes stuff would get right.
o A>B & B>A; risky thing more expensive
People learn from their mistakes
o Not with high stakes (not often)
Invisible handwave
o Markets cannot make you rational
