Spock didn't face many of the difficulties that come with making decisions.
We love to laugh and cry.
At times, we seek revenge and at other times, we seek forgiveness.
We can be short-sighted and impulsive, and fail to see the benefits of pursuing long- run gains.
Although they do not fit within our economic models, each of these behaviors is real.
The standard economic model of behavior does not take into account the complexity of human decision- making.
We consider why people don't make rational decisions in this chapter.
Spock and the Vulcans use logic to make decisions.
James Kirk is subject to many biases.
One key difference is that psychologists don't assume that people always behave rationally.
Experimental psychology can be used to describe human behavior.
Economic theorists don't want to explain why people might make an impulse purchase because they assume that people make optimal decisions.
Economists understand that many behaviors are not able to solve the problem of rationality.
Bounded rationality can be explained in three different ways.
The information that the individual uses to make a decision may be limited or incomplete.
The human brain is limited in its ability to process information.
There is a limited amount of time to make a decision.
The decision maker can't reach the results predicted under perfect rationality.
Suppose you're about to get married and you find yourself at Kleinfeld Bridal with your bridesmaids.
You enter the store to look for a wedding dress.
You find a dress that you like, but its price is higher than you were planning to spend.
If you think the value is high enough to justify the price, you should buy.
You have a limited amount of information.
In a rational world, you would check out alternatives in other stores and on the internet and then make the decision to purchase the dress only after you are satisfied that it is the best possible choice.
A dress you tried on at one location can be a dress you tried on elsewhere.
Under a deadline, wedding dresses are selected.
The bride must make a decision quickly.
There are three reasons that prevent a bride from achieving the result that economists predict.
You walk into a store, see something you love, and make a purchase using partial information.
The decisions reflect rationality when people end up making them.
We will look at vari ous behaviors that don't fit assumptions about rational behavior.
There are misperceptions of probabilities, inconsistencies in decision making, and judgments about fairness when making decisions.
The goal in this section is to help you understand the differences between what economic models predict and what people actually do.
Economic models don't account for how people perceive the probability of events.
High- probability events are often under anticipated.
We consider several familiar examples, including games of chance, difficulties in assessing probabilities, and seeing patterns where none exist.
Playing games of chance is a losing proposition.
Millions of people spend money on games of chance despite the odds being against them.
For some people, the chance of winning a lottery gives them hope that they will be able to purchase something they need but can't afford.
People have incomplete information about the probabilities and prize structures.
The exact odds of winning are not calculated by most lottery players.
People are excited about playing if the game has a positive expected value, which is why lottery agencies highlight winners.
Imagine if every headline trumpeted the newest lottery millionaire was followed by the names of the people who lost.
The irrational belief of players is that they have control over the outcome.
They are certain that playing certain numbers will bring success.
Many players feel that they must stick with their favorite numbers to avoid regret, and everyone has heard of players who changed their lucky pattern only to watch it win.
Some gaming behaviors are rational.
The casinos can be beaten by betting strategically and paying close attention to the cards.
Some people can win at blackjack by counting the cards that have been dealt.
There is an incentive to gamble if the expected value is positive.
If a friend wants to wager $10 on the flip of a coin and promises you $25.00 if you guess right, the expected value is half of that.
When you have little to lose or no other options, it makes sense to gamble.
The thrill of gambling is enjoyable for some people.
Most gambling behaviors don't have rational motives.
Gambling leads players to make poor financial decisions.
People who gamble do not evaluate probabilities in a rational way.
Gambling is not the only irrational decision- making that happens with many other behaviors.
Traveling by airplane is 10 times safer than traveling by automobile.
Millions of people who refuse to fly do not hesitate to get into a car.
A false sense of control is created by driving.
At the end of the show, the host would ask a contestant to pick a curtain.
A car, a nice but less expensive item, or a worthless joke item could be behind each curtain.
If contestants had used probability theory, they could have maximized their chances of winning the car.
The contestants rarely chose in a rational way.
You pick curtain number 3.
The host, who knows what is behind the curtains, opens curtain number 1 which has a pen filled with chick ens.
You can switch your choice to curtain number 2.
The majority of contestants would stay with their original choice because they think they have a better chance of winning the car now.
The chance that you guessed correctly the first time is the same as it is now.
There is still a chance that one of the curtains contains the car.
With curtain number 1 revealed as the joke prize, that 1/3 probability now belongs to curtain number 2.
Most contestants don't switch for fear of regretting their decision, because they think that each of the two remaining curtains has an equal chance of holding the car.
Poor decisions are made because of the difficulty in recognizing the true underlying probabilities and the irrational fear of regret.
Understanding these tendencies helps economists to make better decisions.
Studies show that bets on recent are not likely to be repeated winning numbers.
The selection of winning numbers and outcomes that have randomly, just like flipping coins, are due to happen soon.
Someone who uses the gambler's fallacy believes that if many heads have occurred in a row, thentails will occur next.
The study looked at the belief that random sequence can affect the game of basketball.
A player who has scored several baskets in a row, one with a "hot hand", is thought to exhibit a positive correlation.
There was no correlation between success in one shot and success in the next shot.
Some people fall into traps when investing in the stock market.
The gambler's fallacy and the hot hand fallacy wouldn't exist in a rational world.
People are more likely to see patterns in data when there are no.
The rise and fall of the stock market is often believed to be driven by specific events and by underlying metrics such as profitability, market share, and return on investment.
When a downward trend seems to be occurring, investors often react with a herd mentality by rushing into stocks that appear to be doing well and selling them off.
The gambler's fallacy is reflected when investors believe the stock market has run up or down too rapidly.
Some segments of the market are driven by investor psychology.
There is a correlation between the weather and how the stock market trades on a particular day.
The stock market can't give participants a rational performance because the weather in Lower Manhattan could have something to do with it.
Your instructor makes sure the exam answers are distributed randomly.
When you consider the next question, do you ever wonder what it means?
You don't know the answer comes up and you have to guess.
The gambler's fallacy says that recent events are less likely to happen again in the near future.
The gambler's fallacy is at work in your decision to avoid marking another C.
People would always be consistent if they were completely rational.
Research has shown that the way a question is asked affects our responses.
Many of us make bad decisions.
In this section, we look at a variety of decision- making mistakes.
There are a number of ways in which economic models don't account for the behavior of real people.
Consider an employer sponsored retirement plan.
Studies show that workers are asked if tives are presented.
The psychological thriller from 1998 tries to make sense of chaos.
Max Cohen is using his computer to find patterns in the stock market.
Nature uses mathematics as a language.
Max's quest reminds us that the average inves identify a mathematical pattern that will predict the tor lacks full information, but still irra behavior of the stock market.
He is pursued by two parties as he gets closer to believing that he or she knows something.
A Wall Street firm that wishes to use Max's discovery tions about the true probability of events can lead to manipulate the market and a religious person who believes that the pattern is a code sent from God.
Con when the order sider two groups of college students.
The first group is asked how happy they are.
The questions are presented in reverse order.
Those who had more dates believed they were happier because they were reminded of the number of dates first.
When an objective evaluation of their current stances suggests that a change would be beneficial, decision makers try to protect what they have.
People are affected by the status quo bias.
The cost of this behavior is missed opportunities.
An individual with status quo bias would maintain a savings account with a low interest rate, instead of shopping for better rates elsewhere.
The benefits of higher returns on savings would be lost by this person.
Many potential customers prefer to leave things the way they are, even if something new might make them feel better, because status quo bias explains why new products and ideas have trouble gaining traction.
Consider the $1 coin.
If people used the $1 coin, the government would save $5 billion in production costs over the next 30 years.
It is not a slam dunk policy change.
Americans like their dollar bills and rarely use the $1 coins in circulation, even though they frequently use nickels, dimes, and quarters to make change, feed parking meters, and to buy from vending machines.
The status quo bias has prevented the change from happening, even though introducing more of the $1 coin and eliminating the $1 bill would be rational.
More than 25,000 organ transplants take place in the United States each year, with the majority coming from deceased donors.
Demand is much higher than supply.
Over 100,000 people are waiting for an organ donation.
Most Americans are aware of the need and support donation.
Only 30% of people know how to become a donor.
The opt- in system and the opt- out system are the main donor systems.
Individuals are required to give explicit consent to be donors.
Anyone who has not explicitly refused is considered a donor.
The United States requires donors to opt in.
Many states have sought to raise donation awareness by allowing consent to be noted on individual driver's licenses.
Many people who would be willing to donate organs never actually take the time to complete the necessary steps to opt in.
In countries like France and Poland, people must opt out if they want to donate their organs.
The strategy yields higher organ donation rates than opt-in programs.
The results should be the same according to traditional economic analysis.
The framing effect is illustrated by the fact that we find strong evidence to the contrary.
opt-out programs automatically enroll eligible people unless they explicitly choose not to, which is one of the most successful applications of behavioral economics.
The same incentives and freedom of choice can be found in opt-out programs, where members are not required to participate.
Here are three remarkable results.
Temporal decisions are made across time.
Planning to do something over a period of time requires the ability to value the present and the future consistently.
Many people don't end up saving enough for retirement because they don't value time enough.
The temptation to spend money is overwhelming.
A person wouldn't need help saving enough for retirement in a rational world.
In the real world, workers depend on 401(k) plans and other work- sponsored retirement programs to deduct funds from their paychecks so that they don't spend that portion of their income on other things.
Can you not eat one run objectives?
One at a time, individual children were led into a room and offered a treat.
The researchers told the children that they could either eat the marshmallows immediately or wait 15 minutes and get a second one.
The children in the study ate the marshmallows slowly.
Most of the time, they tried to fight the temptation.
One third of those who tried to wait were able to get the second marshmallows.
That finding is interesting, but what happened next is truly amazing.
Many of the parents of the children in the original study noticed that the children who had delayed gratification seemed to perform better as they progressed through school.
Researchers tracked the participants over the course of 40 years and found that the group with delayed gratification had higher SAT scores, more savings, and larger retirement accounts.
Standard economic theory cannot explain the pursuit of fairness, a common behavior that is important in economic decisions.
One of the key drivers of tax rate structure for income taxes is fairness.
Proponents of fairness believe that the rich pay a higher tax rate on their income than the poor do.
Some people object to the high pay of chief executive officers or the high profits of some corporations because they believe there should be an upper limit to what constitutes fair compensation.
Two players decide how to divide a game, which shows how fair the decision- making process is.