Behavioral economist Dan Ariely’s research has found that the cumulative impacts of various forms of cheating has a significant impact on the world economy. His experiments show that people, across a wide range of situations, will cheat just a little bit, even when given the opportunity to get away with more; but reminders of core values, such as codes of ethics, can reduce cheating. He discusses the implications of these ideas for managers and professional organizations.
Q: There’s an ongoing discussion about whether business could or should be a profession. What does your research show about whether professions in general lead to honest or ethical behavior?
We don’t have direct research on professions. It’s very hard to compare people before they become professionals and after. But we do find that codes of ethics of the sort that professions often have are, on the one hand, very important and, on the other hand, very dangerous. The good side is that they guide you to stay away from potentially ethically compromised situations. On the bad side, if professionals see their peers stretching boundaries and they go along, there’s a chance for very quick deterioration.
People have two goals: We want to look in the mirror and feel good about ourselves, and we want to benefit from cheating. You would think you couldn’t get both, but our psychology is sufficiently flexible that we can as long as we cheat just a little bit. We have found this to be the case in experiment after experiment.
In my view, most people who behave badly are not bad people. They’re just good people who are put in bad situations—where it’s tempting and easy to cheat a little bit. Look at the whole financial crisis, if you and I were getting paid $8 million a year to view mortgage-backed securities as good products, we could do it. It’s inhumane to put people in situations that have tremendous conflict of interest and expect them to be unswayed by it. Ideally, professions eliminate these problems by not making people face them.
My favorite Question (via QN)
Q: How regularly do we have to be reminded in order to have that impulse to act more honestly?
Sadly, I think quite frequently. But we don’t have to be highly thoughtful about morality all the time. We really need to do it at important points in time. For example, I proposed to the Israeli IRS to move the Israeli tax day to be next to Yom Kippur, the Day of Atonement. I don’t know if it would work, but the idea is that you have people already contemplating their decisions, so they may be more inclined to be more honest. Similarly, you might be thinking that April 15th is not a good day for American tax day. If you linked it with New Year’s when people set resolutions and try to turn a new page, people might actually report different taxes.
This column argues responses to the recession should not be based on unrealistic expectations of rational behaviour. It argues that models of bounded rationality provide reasons that traditional macroeconomic policy responses may fall short and suggests more sophisticated solutions that could break the crisis’s psychological hold on markets.
Excerpt (via Vox.eu)
Bounded rationality is the broad term for behavioural models that do not follow the rational-maximiser formula. There is not yet a generally accepted alternative model. Lots of individual non-rational behaviours have been discovered, but they are grafted onto a rather clunky ‘rational actor with bits’ instead of forming a coherent behavioural model.
However, the best place to test a new theory is often at the edges of the old one, where the existing model breaks down. So the current troubles in the financial and real economy may be a good opportunity to try out some alternative models and see which give a reasonable description of what we see.
Models of bounded rationality
Different models of bounded rationality vary basic assumptions of the rational agent model in different ways. Some of those assumptions are:
* Utility is discounted over time in a consistent way
* People have access to all relevant information
* All relevant information is expressed through market prices
* People can instantly weigh up the change in utility given by any buying or selling decision
* People act to maximise their utility
One of my favorite researchers of all time and the mastermind of prospect theory and eventually behavioral economics/finance.
About this talk (via TED)
Using examples from vacations to colonoscopies, Nobel laureate and founder of behavioral economics Daniel Kahneman reveals how our “experiencing selves” and our “remembering selves” perceive happiness differently. This new insight has profound implications for economics, public policy — and our own self-awareness.
About Daniel Kahneman (via TED)
Daniel Kahneman won the Nobel in Economics for his pioneering work in psychology — exploring the irrational ways we make decisions about risk.
This paper proposes that task format (choosing or rejecting) moderates the effect of ambiguity aversion. Specifically, an ambiguous option is more attractive in a choosing task than in a rejecting task compared with a risky option. The author performed three experiments to test the propositions. In the first experiment, participants showed less ambiguity aversion when they had to choose a preferred option (risky or ambiguous) compared with when they had to reject an option they preferred less. In the second experiment with a monetary incentive, participants had to form a cash-equivalent estimate for both a risky gamble and an ambiguous gamble in a traditional Ellsberg scenario. The ambiguous option emerged as more attractive than the risky option in the choosing task compared with the rejecting task. The third experiment showed that the participants’ decision rationale mediated the effect of the task format on choice. These three experiments support the proposition that task formats moderate the effect of ambiguity aversion. On the basis of the findings, the author provides suggestions for practice and further research.
Paper 2: The influence of aging on preferences for sequences of mixed affective events (click here to for the paper)
Research on preferences among sequences of mixed affective events has mostly used young adults as participants. Given differences due to aging in people’s ability to regulate emotion, one could expect differences due to aging in preferences for different sequences. Study 1 demonstrated age-related differences in how older adults (age 65 and older) versus young adults (age 18-25) choose to order mixed affective events that will occur over time. The tendency to choose sequences in which the final event is positive was greater among older adults versus young adults. And, more so than young adults, older adults preferred that the positive and negative events in a sequence be separated in time by a neutral event. Studies 2-3 investigated age-related differences in overall retrospective evaluations of presented sequences of mixed affective events. In contrast to young adults, older adults’ retrospective evaluations were not affected by: (1) whether the final trend of the sequence improved monotonically; (2) whether the last event in the sequence was positive; or (3) the temporal proximity of positive and negative events in the sequence. Results of Study 3 suggest that these age-related differences are due to differences in older (vs. young) adults’ ability to regulate emotion.
“Conversations host Harry Kreisler welcomes Princeton Psychology Professor Daniel Kahneman for a discussion of his Nobel prize winning research on intuition and decision making.”
Simplifying the title, people over react to the benefits of wealth.
“Our results are in line with Kahneman et al’s (2006) suggestion that people focus too much on the impact of this one variable on their global life satisfaction, part ofa more general tendency to overweight single inputs when estimating overall satisfaction (Hsee & Rottenstreich, 2004).”
While numerous studies have documented the modest—though reliable—link between household income and well-being, we examined the accuracy of laypeople’s intuitions about this relationship by asking people from across the income spectrum to report their own happiness and to predict the happiness of others (Study 1) and themselves (Study 2) at different income levels. Data from two national surveys revealed that while laypeople’s predictions were relatively accurate at higher levels of income, they
greatly overestimated the impact of income on life satisfaction at lower income levels, expecting low household income to be coupled with very low life satisfaction. Thus, people may work hard to maintainor increase their income in part because they overestimate the hedonic costs of earning low levels of income.
Introduction (via Aknin, Norton, & Dunn)
A striking inconsistency surrounds the relationship between money and happiness. Despite the fact that money has been shown to have a small – though reliable – effect on happiness in developed countries (Diener & Biswas-Diener, 2002; Frey & Stutzer, 2000), humans devote much of their time and energy to earning it, seemingly motivated by the belief that money will have a substantial impact on their overall life satisfaction (Ahuvia, 2008). For example, the amount of time the average American spends at work has grown steadily over the past several decades, despite the fact that this occupational investment comes at the cost of family and leisure time (Schor, 1991). What is the source of this apparent contradiction between researchers’ conclusions about the relatively modest link between money and happiness versus laypeople’s everyday choices and behavior? We suggest that laypeople engage in behaviors designed to increase or maintain their wealth because they overestimate the impact that income has on well-being.
Introduction (via Mc. Kinsey Quarterly)
Long before behavioral economics had a name, marketers were using it. “Three for the price of two” offers and extended-payment layaway plans became widespread because they worked—not because marketers had run scientific studies showing that people prefer a supposedly free incentive to an equivalent price discount or that people often behave irrationally when thinking about future consequences. Yet despite marketing’s inadvertent leadership in using principles of behavioral economics, few companies use them in a systematic way. In this article, we highlight four practical techniques that should be part of every marketer’s tool kit.
Keys To Behavioral Marketing: (via Mc.Kinsey Quarterly)
1. Make a product’s cost less painful-
In almost every purchasing decision, consumers have the option to do nothing: they can always save their money for another day. That’s why the marketer’s task is not just to beat competitors but also to persuade shoppers to part with their money in the first place.
….
Another way to minimize the pain of payment is to understand the ways “mental accounting” affects decision making. Consumers use different mental accounts for money they obtain from different sources rather than treating every dollar they own equally, as economists believe they do, or should. 2. Harness the power of a default option
The evidence is overwhelming that presenting one option as a default increases the chance it will be chosen. Defaults—what you get if you don’t actively make a choice—work partly by instilling a perception of ownership before any purchase takes place, because the pleasure we derive from gains is less intense than the pain from equivalent losses. When we’re “given” something by default, it becomes more valued than it would have been otherwise—and we are more loath to part with it. 3. Don’t overwhelm consumers with choice
When a default option isn’t possible, marketers must be wary of generating “choice overload,” which makes consumers less likely to purchase. In a classic field experiment, some grocery store shoppers were offered the chance to taste a selection of 24 jams, while others were offered only 6. The greater variety drew more shoppers to sample the jams, but few made a purchase. By contrast, although fewer consumers stopped to taste the 6 jams on offer, sales from this group were more than five times higher
4. Position your preferred option carefully
Economists assume that everything has a price: your willingness to pay may be higher than mine, but each of us has a maximum price we’d be willing to pay. How marketers position a product, though, can change the equation. Consider the experience of the jewelry store owner whose consignment of turquoise jewelry wasn’t selling. Displaying it more prominently didn’t achieve anything, nor did increased efforts by her sales staff. Exasperated, she gave her sales manager instructions to mark the lot down “x½” and departed on a buying trip. On her return, she found that the manager misread the note and had mistakenly doubled the price of the items—and sold the lot. In this case, shoppers almost certainly didn’t base their purchases on an absolute maximum price. Instead, they made inferences from the price about the jewelry’s quality, which generated a context-specific willingness to pay.
My friend Tim of the PsyFi blog has a written a fantastic thought paper on our bias towards round numbers. This is a very very good post. I also recommend reading the cited literature..Cheers.
One of the odder things about the universe is that the small set of numbers that define its structure, the so-called universal constants, don’t seem to have any structure of their own. You’d have thought that whatever immortal deity breathed life into the whole shebang would have at least have bothered to make sure that reality was defined in simple integer values your average gameshow contestant could remember. Yet someone’s just calculated Pi to more decimal places than you can read in a lifetime. The universe is strangely irrational, it would seem.
More likely, however, is that the irrationality lies in our heads. If you look at the way we treat numbers for investment purposes it’s probably a good job the infinite cosmos is specified in irrational numbers, because if it were otherwise we’d probably have sold it to the lowest bidder eons ago. Humans, it seems, treat numbers as an approximation to reality, unlike reality; which treats humans as an approximation to nothing.
“UCLA economist Matthew Kahn picks up on a neat little story about Los Angeles Lakers coach Phil Jackson’s use of psychology in his NBA locker rooms. Ever the behavioralist, Jackson fined his players tiny amounts – $10 and $20 – for being late to games by a few minutes.
Jackson has found that players are more grudging about having to pull cash out of their own pocket on the spot, than having a larger fine deducted from a paycheck, as is the usual practice.”
This paper attempts to bring some central insights from behaviouraleconomics into the economics of climate change. In particular,it discusses (i) implications of prospect theory, the equitypremium puzzle, and time-inconsistent preferences in the choiceof discount rate used in climate-change cost assessments, and(ii) the implications of various kinds of social preferencesfor the outcome of climate negotiations. Several reasons arepresented for why it appears advisable to choose a substantiallylower social discount rate than the average return on investments.It also seems likely that taking social preferences into accountincreases the possibilities of obtaining international agreements,compared to the standard model. However, there are also effectsgoing in the opposite direction, and the importance of sanctionsis emphasized.
