The surprising power of behavioural economics

Behavioural Economics

Economics Options Course
Autumn 2012

The surprising power of
Free: Time Out magazine
triples the readership it
predicted when going free

Students who use cash to
pay for lunch tend to make
healthier choices

Econs v Humans
• ECONS • HUMANS
• Super-smart • Flawed
• Rational • Biases in behaviour
• Well defined preferences • Social animals
• Self-interested / selfish • Emotional – hot and cold
states
• Utility maximizers
• Not driven purely by a need to
maximise their welfare
• Lack of self-control - at the
heart of many undesirable
behaviours, such as
overeating, overspending, and
even overworking

Messenger

Ego Incentives

Social
Affectation
Norms
Behavioural
Choices

Commitment Defaults

Priming Salience

Beware the Messengers and Gurus

• We can be heavily influenced by who communicates
information to us
• Expert bias
– Expert witnesses in trials and in the media
– The God complex and poor decision making
• Media as the Messenger – e.g. The Daily Mail Project
• Impact of peer effects and social networks

As of February 2012, there have been
seventy-nine known deaths since January
2007, though police have found no
evidence to link the cases together. Of 25
people who killed themselves between
January 2007 and February 2009, all but
one died from hanging

Incentives Matter!
Incentives Magnitude

Risk
Type Timing Framing
Attitudes

Non Pay off Pay off in
Financial
Monetary now future

Rewards Penalties Reciprocity Status

Extrinsic Intrinsic

Which do you prefer?

£10 TODAY


£10 TODAY £12 TOMORROW


£10 IN A WEEK’S
TIME


£12 IN 8 DAYS £10 IN A WEEK’S
TIME TIME

Defaults Opt Out
(France)
Standard Organ
practices Donation
Natural order Opt In (UK)
Non-working
households

Default
Menu choices
Choice

Software
settings
Convenience
Friday nights

GP
prescriptions

Networks & Linkages

The preferences of agents are
not fixed, they evolve in many
ways. Specifically, they can be
altered directly by the behaviour
of other agents
We are dealing in general with
systems of interacting agents
which are out of equilibrium –
complex systems

Paul Ormerod

Salience

Our attention
is drawn to
what is novel
and seems
relevant to us

Errors that affect you personally can completely
change the rule of thumb that you use when driving
– i.e. The risk of being caught by a speed camera

Priming

Behaviour
affected by
exposure to

Sights Words Sensations Touch Smell

Subliminal
Images Objects
messages

Priming

Priming explains how our recent
experience influences our
thoughts, feelings and behaviour.

Small changes to the context of
an experience can change the
way we respond

1/ Was Gandhi younger than 60
when he died? (Yes or No?)

2/ Estimate Gandhi‟s age when he
died (in years)

A: The Price of a London Hotel Room
a) Do you think the price of this room is
less than or more than £250 per night
(answer: Less / More)

b) How much would you expect to pay for
a night in this London hotel (write
your answer in £s)

1/ Was Gandhi younger than 115
when he died? (Yes or No)

2/ Estimate Gandhi‟s age when he
died (in years)

B: The Price of a London Hotel Room
a) Do you think the price of this room is
less than or more than £70 per night
(answer: Less / More)

b) How much would you expect to pay for
a night in this London hotel (write
your answer in £s)

1/ Was Gandhi younger
than 85 when he died?

2/ Estimate Gandhi‟s
age when he died (in
years)

Gandhi died at the age of

78

1/ Was Gandhi younger
than X when he died?

2/ Estimate Gandhi‟s
age when he died (in
years)

Gandhi died at the age of

78

Framing the cost of high street credit

Which has most effect? Showing the
repayment total or representative APR %?

Anchoring with charitable giving

Social Persuasion: Facebook and
organ donation (2012)

Facebook‟s donor-registration strategy allows people to announce to their
friends what they have done, encouraging them to become donors, too.
Studies have shown how information about people‟s decisions to perform a
public good can persuade others to follow suit

Dominos
and
Electronic
Pennies

New York Taxis – Framing Tips!
During payment, the
user is presented
with three default
buttons for tipping:
20%, 25%, and
30%. When cabs
were cash only, the
average tip was
roughly 10%. After
the introduction of
this system, the tip
percentage jumped
to 22%.

Priming knowledge about price can
have strong behavioural effects

Commitment to change behaviour

Affect

• Emotional associations can powerfully shape our actions
• All perceptions contain some emotion
• How best to create an emotional reaction to perhaps
bring about behavioural change?
• Should some messages be presented in a counter-
intuitive way to influence our emotions and choices?
• Human desire for reciprocity widely seen as strong and
potentially very important in nudging social and
economic behaviours

Self image
Ego
Self esteem
Self-fulfilling expectations
we act in ways that make us feel
better about ourselves Self-attribution bias
Group identification

Behaviours

• Cognitive – heuristics, mental rules of thumb that make
decisions easier
• Chemical – the brain prefers actions with positive
outcomes that release a feel good hit
• Social – acting as others do is easier and feels good

Visual perception and mental effort

• Priming, framing and anchoring provide ways in
which smart marketing can change perceptions
and influence the choices we make.
• We are all prone to visual illusions
• Subliminal messages can have powerful effects
• We tend to baulk at tasks that take intense
mental effort – system 2 runs low!

Rationality and tricks of the mind

Loss aversion
• Emotional and perceptual asymmetries between
losses and gains
– Losses loom larger than gains
– People go out of their way to avoid losses, but they
would not bother to go out of their way to gain
something
– Diminished sensitivity to larger losses
• Linked to the endowment effect
– People try to keep something that they consider is
„theirs‟, even when it is quite arbitrarily given

Starbucks and Cutting Waste

1/ Charge customers 10 cents for every paper cup they
use i.e. List price $1.50 rises to $1.60

2/ Bring a reusable travel mug and get a 10 cent
discount on any Starbucks beverage, anytime List price
of $1.60 falls to $1.50 if a reusable mug is used

The Endowment Effect

Back in the 1950s, when the focal
practice of baking was displaced by
the advent of cake mix, Betty
Crocker learned quickly that it was
good business to make the mix not
quite complete. The baker felt better
about her cake if she was required
to add an egg to the mix

IKEA and the Endowment Effect

IKEA customers are
loyal to their self-
assembled furniture
because there is a
piece of them in it

Heuristics
• Heuristics are experience-based
techniques that we apply to
solving problems
– Educated guesses
– Rules of thumb
• Main heuristics are
– Availability
– Anchoring
– Representativeness /
similarity
– Cognitive biases
• Loss aversion
• Status quo

Availability heuristic

• False estimation of risk
• Predicted frequency / likelihood of an event based on
how easily an example can be brought to mind (saliency)
• Fear often exaggerates the likely danger
• Come up with some examples

Consider these two scenarios

• A massive flood
somewhere in North
America next year, in
which more than
1,000 people drown

Consider these two scenarios

• A massive flood • An earthquake in
somewhere in North California sometime
America next year, in next year, causing a
which more than flood in which more
1,000 people drown than 1,000 people
drown

The Availability Heuristic

• Which has more?
– 1) Words that begin with the letter "R"
– 2) Words that have the letter "R“ in the third position

The Availability Heuristic

• Which has more?
– 1) Words that begin with the letter “K"
– 2) Words that have the letter “K“ in the third position

Availability heuristic

• Which has more?
– Words that begin with the letter "R" or "K"
– Words that have the letter "R" or "K" in the third
position
• Answer
– Words that have the letter "R" or "K" in the third
position are more common.
– There are three times as many words that have
the letter "K" in the third position

Hyperbolic discounting and the zero
price bias
• Which would you rather • Which would you rather
have? have?
• 50% off a new £20 shirt • Receive a free £10 gift
if you pay in cash certificate
• 1.3% off a new £750 • Pay £7 for a £20 gift
sofa certificate
• £10 off the price of a £80
air ticket if you book
online

Default behaviour

• Default
– Sometimes known as status-quo bias
– Which aspects of your life are default?
– Default settings can become sticky
• Computers and screensavers / sleep mode
• TV schedules – watching one programme after
another
• Choices made in the supermarket

Bounded behaviour
• Bounded behaviour
– People have limited time and capacity to weigh all relevant
benefits and costs of a decision.
– Added complexity can distort choice
• Bounded will-power
– We tend to have more self-control “in the future” than now
• Bounded self-interest
– We are often keen to engage in co-operative behaviour for
the common interest and the common good

Which sequence of eight babies born in
a local hospital is most likely?

In a lake, there is a patch of lily pads. Every
day, the patch doubles in size. If it takes
48 days for the patch to cover the entire
lake, how long would it take for the patch
to cover half of the lake?

Maternity Wards

• A town is served by two hospitals. In the larger hospital,
about 45 babies are born each day, and 15 in the
smaller hospital. You know that roughly 50% of babies
born are boys, though may be higher or lower on a
particular day. Over one year each hospital recorded the
days on which more than 70% of babies born were boys.
• Which hospital recorded more such days?
– LARGE or
– SMALLER

Names for Children

• Mary‟s Father has 5 daughters.
• The first four are called:
• Sante
• Senti
• Sinto
• Sontu
• What do you think the fifth one is called?

Balls

• A baseball and bat together cost $11. The bat costs $10
more than the ball. How much does the ball cost?
• Write down your answer.

Personality Disorder?

• Geoff is shy and withdrawn, invariably helpful, but with
little interest in people. He is meek and tidy, and has a
need for order and structure, and a passion for detail.
• Geoff is most likely to be?
• 1. A Sheep Farmer
• 2. A Salesman
• 3. An Airline Pilot
• 4. A Librarian
• 5. A Novelist

The surprising power of behavioural economics

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