A Very Short Introduction

Behavioural Economics

By Michael Baddeley

Intrinsic vs Extrinsic Motivations

• Intrinsic Motivation — Influence of our internal goals and values. We are motivated by something inside ourselves like pride, duty, loyalty to a cause or the enjoyment of a challenge.
• Extrinsic Motivation —Incentives and rewards external to us as individuals. If we don’t want to do something but do it anyway we are pushed to do it by this external force. Examples include salary or physical threat.

Crowding Out

Extrinsic motivations can “crowd out” intrinsic ones. Intrinsic motivation is decreased by external reward.

Study #1 — One set of students was asked to do a certain tasks unpaid while another was paid a small fee. The set of unpaid students would commonly perform better than those who are paid. Why? It could be that the unpaid students were motivated by the challenge and the paid were demotivated by the low pay.

Study #2 — Economist Uri Gneezy and Aldo Rustichini did a study on nursery attendance. A nursery had a problem with parents picking there kids up late from school. The nursery added a fine as a deterrent. With this fine, more parents turned up late. The external monetary dis-incentive was crowding out the internal incentive to co-operate with the nursery.

Inequity Aversion

People do not like to see unequal outcomes with this being called inequity aversion. Many studies have confirmed this across the world and across the animal kingdom. The most famous being the Ultimatum Game.

Player A has a sum-say £100-and can offer whatever amount to Player B. If Player B rejects the offer both players get nothing. If Player B accepts the offer then Player A gives this portion over and keeps the remainder. Traditional economists suggests that Player A will offer £1 and as £1 > £0 Player B will accept this outcome.

The conclusions from this test being performed are that people are generous than thought (offering more than £1) and that people do not accept unfair offers below normally 40%.

Wikipedia- “Based on fMRI studies of the brain during decision-making, different brain regions activate dependent upon whether the participating subject “accepts” or “declines” an offer. Since to “decline” means that neither receives any money, the responder is actually “punishing” the player who makes a low offer. Punishing activates the part of the brain that is associated with the dopamine pathway — i.e. it provides pleasure to punish. Hence, the subjects who refuse and punish in the process, possibly receive more pleasure from punishment than they would from accepting a low offer. This is, therefore, an expected utility argument where the currency is in pleasures received rather than goods or their associated values in money.”

Herding

An important part of human behaviour involves our tendency to follow crowds.

Social Psychologist Solomon Asch found that even in very simple decision making tasks we tend to follow the crowd. Asch found that when the participants were included in groups all giving obviously wrong answers to simple questions the participant would often change their mind and agree with the group.

simplepyschology.org

“Asch used a lab experiment to study conformity, whereby 50 male students from Swarthmore College in the USA participated in a ‘vision test.’

Using a line judgment task, Asch put a naive participant in a room with seven confederates/stooges. The confederates had agreed in advance what their responses would be when presented with the line task.

The real participant did not know this and was led to believe that the other seven confederates/stooges were also real participants like themselves.”

Each person in the room had to state aloud which comparison line (A, B or C) was most like the target line. The answer was always obvious. The real participant sat at the end of the row and gave his or her answer last.

There were 18 trials in total, and the confederates gave the wrong answer on 12 trails (called the critical trials). Asch was interested to see if the real participant would conform to the majority view.

Asch’s experiment also had a control condition where there were no confederates, only a “real participant.”

Heuristics

Kahneman and Tversky have pioneered work on heuristics and how they generate biases. There are three main types of Heuristics.

• Availability — When making a decision we do not take into account all information but the most easily accessible information which is usually the most recent.
• Representations — We are quick to draw comparisons to events and jump to conclusions. This is best captured in the “Linda Problem” in which participants are asked to read some information about a women named Linda (that she is in her 30s, clever and concerned with social justice and discrimination). They are then asked “what is more probable? Linda is a bank teller or Linda is a bank teller and a feminist”. Many people would select Option 2 despite it being statistically less probable than 1!
• Anchoring and Adjustments — Humans anchor our decisions are a reference point and adjust from this point. One study involved students being asked to estimate 8x7x6x5x4x3x2x1 and another 1x2x3x4ix5x6x7x8. Those in the first group gave higher estimates than the second as they started with a higher number.

Prospect Theory

Prospect theory is a behavioural model that shows how people decide between alternatives that involve risk and uncertainty. It demonstrates that people think in terms of expected utility relative to a reference point(e.g. current wealth) rather than absolute outcomes.

Prospect theory indicates that people are loss-averse; since individuals dislike losses more than equivalent gains, they are more willing to take risks to avoid a loss.

OCEAN

Behavioural economists can use the OCEAN tests to define personality. OCEAN is based around the Big Five Model of Personality:

O-Openness to Experience, C-Conscientiousness,E-Extroversion,A-Agreeable and N-Neuroticism.

Somatic Markers

Neuroscientists Antonio Damasio takes a positive view of how emotions drive our decisions. Emotions are associates with cues manifested in our bodily responses called somatic markets. Knowledge from these markers are communicated via our emotions. For example, if you are burnt by fire the next time you see a flame you may feel fear with this being knowledge imparted through emotions.

One of the most famous examples is Phineas Gage who following a railroad accident damaged his frontal lobe which is associated with higher level cognitive functioning. , Dr. Antonio Damasio said, the case offers compelling evidence that the human brain has a specialized region for making personal and social decisions and that this region, located in the frontal lobes at the top of the brain, is connected to deeper brain regions that store emotional memories. When this higher brain region is damaged in a certain way by stroke or injury, he said, a person undergoes a personality change and can no longer make moral decisions.

Social Nudges

Thaler, one of the pioneers of Nudge theory, often uses the example of household energy consumption. Wesley households were given two types of information. The first set was given information on other households energy consumption to act as a reference point and tips on how to save. The second set was only give information on how to reduce energy consumption. The households in the treatment group were more likely to adjust their energy usage vs the control.