Economics is threatening to get fun, after years of being labelled as the “dismal science.”
Economists and psychologists have been teaming up to investigate how people make decisions in real life, as opposed to the rational decision-makers we are assumed to be in classical economics. Researchers call this “behavioural economics” and have revealed humans are a rather alarming mix of Star Trek’s Mr. Spock ... and Homer Simpson.
The theory is that as humans evolved, our brains developed a series of quick and dirty decision-making protocols that appear to be hardwired into our brains. These instincts are overlaid with our more rational thought patterns, creating a constant battle between your inner-Homer and your inner-Spock.
A couple of examples will illustrate the point, starting with some simple math questions.
Say it takes five trappers five minutes to skin five marten. How long will it take 10 trappers to skin 10 marten?
Most people, including university professors being filmed by researchers it turns out, will say, “Ten minutes.”
Of course the answer is five.
Or if you tell people the pile of cardboard in the recycling centre is doubling every week and that the storage lot will be full in 10 weeks, and then ask them how long it will take to be half-full, they will almost always say, “Five weeks.”
As the Yukon News’s razor-sharp readership will have already divined, the answer is nine.
While these simple tricks may not seem too serious, they generalize into a broad finding that the rational side of humans, built up by years of schooling, is seldom in charge. We seem to be hardwired to make several categories of mistakes.
One of the most potent is “anchoring,” in which your brain’s exposure to a number irrationally influences a decision.
According to Dan Gardner in his new book Risk, for example, some researchers put a pile of soup cans in a supermarket. Most shoppers bought just one or two cans. Then they put a sign up that announced a limit per customer of 12 cans. After that most shoppers bought four to 10 cans, no doubt thinking they were outsmarting store management by not buying the full 12.
Other researchers discovered the “anchor” number doesn’t even have to be linked logically to the decision. If you ask people the last three digits of their phone number, and then what year Attila the Hun attacked Europe, the answers are highly correlated.
Another is “status-quo bias,” which is the tendency to keep doing the same thing even though you would choose a different path if making a fresh decision. A famous example of this is a study of the retirement-investment plans of college professors. Likely all the participants knew that, as you age, you should generally adjust the riskiness of your portfolio and move towards bonds and cash. Yet more than half the professors had never made even one change to their asset allocation.
“Availability” is another effect we see regularly, in which people assess risk by how readily examples come to mind. This results in people incorrectly believing that spectacular events, such as plane crashes, are much more likely to kill them than chronic diseases or getting run over while jaywalking across Second Avenue.
“Representativeness” is another intriguing mental lapse, where familiar stereotypes cloud our judgment. In studies, people generally respond that “a massive flood somewhere in America in which 1,000 people die” is less likely than an “earthquake in California, causing massive flooding, in which 1,000 people die.” However, the first has to be more likely since it covers floods in all 50 states not just California and floods from all causes not just earthquakes. But people choose the California example since we’ve all heard of Californian earthquakes, which makes that scenario seem more plausible somehow.
Money, as you might expect, is the root of an entire set of irrationalities. “Money illusion” is a famous effect where we focus on nominal values rather than figuring in inflation. People are happy to accept a two per cent raise when inflation is four per cent, but will fight a two per cent pay cut when inflation is zero per cent.
People also do poorly reacting to rates and percentages, which is why union negotiators ask for “4.5 per cent per year over two years” rather than “a raise that works out to $7,500 raise for our best-paid members” even if these are equivalent.
And one last example - there are more - is “systematic over-optimism.” For example, entrepreneurs systematically believe their businesses will be more successful than they are. It is reminiscent of Samuel Johnson’s quip that second marriages are the triumph of hope over experience.
Why is this important, rather than merely just interesting? Because, if you haven’t noticed already, this field of economics is going mainstream, with dozens of books and articles appearing in the last few years from authors such as Malcolm Gladwell and Dan Ariely as well as Nick Gardner.
We’ve seen people use these tricks before to manipulate others, but now our politicians and corporations are starting to deploy these stratagems systematically.
So keep these tricks in mind next time someone gives you a sales pitch. And watch for next week’s column, which will report on federal Finance Minister Jim Flaherty’s budget speech, and whether he pitched it to our rational side ... or to our inner Homer Simpsons.
Keith Halliday is a Yukon economist and author of the Aurore of the
Yukon series of historical
children’s adventure novels.