"Misbehaving: The Making of Behavioral Economics" is an important work by Richard Thaler that delves into the formation of behavioral economics and its challenges to traditional economics. The book is sprinkled with interesting stories of Thaler's intense confrontations with traditional economic thought, exploring the deep-seated weaknesses of humans in a unique way. When economics meets psychology, the sparks that fly will have profound and enlightening effects on individuals, managers, and decision-makers.#
Here are the main contents and notes of the book:
"The foundation of political economy, or more broadly, the foundation of every social science, is clearly psychology. One day, we will certainly be able to derive the laws of social science from psychological principles."
——Vilfredo Pareto, 1906
My interest in behavior and psychology began eight years ago (in 2012) when I read a book titled "The Happiness Advantage: The Seven Principles of Positive Psychology That Fuel Success and Performance at Work." The "20-second rule: Minimize the barriers to change" introduced in that book still lingers in my memory, and I continuously practice it in my life, which has been immensely beneficial.
Since then, I have been adding more books on psychology and behavioral economics to my reading list, feeling a sense of regret for not discovering them sooner. Recently, I fluidly finished reading "Misbehaving: The Making of Behavioral Economics," which deepened my thoughts about changing careers.
The author uses 400 pages to narrate the emergence, development, and future of behavioral economics, combining various real-life cases with scientific experiments to refute traditional economic theories such as "rational economic man" and "efficient market hypothesis," proving the scientific nature and practical significance of behavioral economics. The logical reasoning and experimental processes discussed are both accessible and beneficial for enhancing thinking and cognition.
The author has made significant contributions to consumer choice, self-control, saving behavior, and finance by employing interdisciplinary knowledge from game theory, finance, labor economics, and psychology. In the book, the author narrates his research on endowment effect, intertemporal choice, mental accounting, saving theory, sunk costs, and behavioral finance theory, providing detailed introductions and analyses of various theoretical anomalies, experimental processes, and real-world applications, which hold strong practical guidance for "ordinary people."
In 2017, Richard Thaler was awarded the Nobel Prize in Economic Sciences for his contributions to behavioral economics. "Misbehaving" is not only an introduction to the history of behavioral economics but also the author's academic autobiography, making it an excellent introductory book on behavioral economics.
Additionally, the book cites and introduces a wealth of academic papers, combining academic rigor with entertainment, even sparking a slight interest in research...
Misbehaving: The Making of Behavioral Economics#
0.1.1 Author: Michelle Pimentel#
Author: Richard H. Thaler
Reviewer: Michelle Pimentel, AFC®
Richard H. Thaler, a professor at the University of Chicago and a behavioral economist, reflects on his lifelong efforts to establish and legitimize behavioral economics in his latest work, "Misbehaving." Thaler defines "misbehavior" as "behavior that is inconsistent with the ideal behavior patterns in economic theory," which does not exist in traditional economic models and can have harmful effects. In this book, Thaler elaborates on the many differences between "human" behavior and the completely rational behavior of "economic man" (the participants used in most economic models), and how incorporating more realistic assumptions into these models can bring tangible benefits to people.
The author mainly clarifies his views through anecdotes and research, making this 400-page economics book both quick and enjoyable to read. Students of economics and finance may find his disruptive views on traditional economic and financial theories both interesting and frustrating, as he reports on many colleagues. Since 1970, he has seized many opportunities throughout his career to emphasize the flaws in these long-held models and recounts many "struggles" with traditionalists throughout the book.
As a social science widely used to influence public policy, Thaler believes economics should be a force for good and proposes several ways government and corporate policies can leverage predictable human "misbehavior" to "nudge" people toward better choices. One well-known example he provides is suggesting that employers construct their retirement plans so that employees "opt out" rather than "opt in," allowing employees to participate in retirement plans with minimal action required. He also advocates a strategy called "Save More Tomorrow," where the percentage of contributions to employer-sponsored retirement accounts automatically increases when employees receive raises.
A key component of behavioral economics is the focus on "humans" (rather than "economic man") and the rationally irrelevant factors (which he calls "supposedly irrelevant factors," or SIFs). Sunk costs are one such SIF. For example, he gives an example where if he and his friend purchased expensive tickets, they would risk unsafe driving conditions to attend a basketball game; however, if the tickets were a gift, they would wisely choose to stay home. He asserts that most of us believe that if we do not gain anything, it is a waste of money, even though the money is spent regardless of whether we watch the game. Rational thinking suggests that the sunk cost of the ticket is irrelevant to the safety of the road conditions, so our decisions should be the same in either case.
Another SIF is sensitivity to changes rather than absolute wealth or value. According to Thaler, most people tend to perceive discounted items as better deals because the discounted price represents a reduction in the amount we have to pay relative to the manufacturer's suggested retail price (MSRP) and other main costs. Therefore, normally priced items are often less attractive than similar items when discounted at the same price. Thus, we may miss out on "transaction utility," or the feeling of having just enjoyed a good deal. If the price and quality of the items are the same, rational actors would have no preference, but "misbehaving" consumers would prefer discounted items.
Another interesting financial topic discussed in the book is the rational economic principle that money is fungible or freely exchangeable, meaning it should flow to the most profitable or needed categories. People tend to treat money as having different values based on the category it is allocated to. For example, a study cited by Thaler attributes the success of tax-advantaged retirement savings accounts (IRAs, 401(k)s, etc.) to savers viewing separate designated accounts as off-limits, while moderate increases in savings rates are attributed solely to actual tax benefits.
A key point that financial advisors can leverage is to suggest some small but effective measures to increase the likelihood of success based on known "misbehaviors," such as automatic savings strategies. This can also serve as a useful perspective for examining our own financial habits to identify areas for improvement. Thaler believes that inertia favors the status quo, and carefully examining our own behaviors may help us change our views on money and consumption habits, thus promoting positive change.
"Misbehaving" is definitely worth a read. The book is humorous, engaging, thought-provoking, and insightful. It does a great job of explaining complex theories, and although the author often praises behavioral economics over traditional methodologies, the book seems to provide a fair analysis of this latest branch of economics.
Michelle Pimentel is a recipient of the FINRA Military Spouse Scholarship and has been an AFC® since 2010. She has been working in personal finance since 2007 and has passed the CFP® exam, making her a CFP® candidate. She is currently a personal finance advisor at Zeiders Enterprises, Inc., serving Air Force members in Okinawa, Japan.
Misbehaving: The Making of Behavioral Economics | Richard Thaler | Google Talks
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0.2 Google Talks#
(https://m.youtube.com/@talksatgoogle)
Richard H. Thaler's entire career has been dedicated to studying the radical view that the core subject of economics is humans—predictable, error-prone individuals. "Misbehaving" describes in an engaging and often humorous way how he has worked to bring a discipline back to reality and change our views of economics, ourselves, and the world. Traditional economics assumes that actors are rational. Early in his research, Thaler realized that these Spock-like robots are completely different from real people. Whether buying alarm clock radios, selling basketball tickets, or applying for mortgages, we succumb to biases and make decisions that deviate from the rational standards assumed by economists. In other words, we misbehave. More importantly, our misbehavior can have serious consequences. Economists initially thought that studying human miscalculations and their effects on markets was just an interesting diversion, but today it drives our efforts to make better decisions in life, business, and government. Thaler combines the latest findings in human psychology with a practical understanding of incentives and market behavior, inspiring readers on how to make wiser decisions in an increasingly mysterious world. He reveals how behavioral economic analysis opens up new perspectives on everything from household finances to allocating faculty offices in new buildings, to game shows, NFL drafts, and companies like Uber. "Misbehaving" is filled with humorous stories of Thaler's fierce battles against the bastions of traditional economic thought, offering a unique observation of human deep-seated weaknesses. The impact on individuals, managers, and policymakers is both profound and entertaining. (PsycINFO Database Record (c) 2016 APA, all rights reserved)
0.3 Author Biography#
Richard H. Thaler, born in 1945, graduated from the University of Rochester in 1974 with a Ph.D. in economics. In 2015, he was elected president of the American Economic Association. He currently teaches at the University of Chicago Booth School of Business (which has produced five Nobel laureates), frequently ranks among the top three business schools globally, and emphasizes theoretical research, case studies, and practical courses. Professor Thaler's research focuses on interdisciplinary fields such as social psychology and behavioral economics, making him a pioneer in modern behavioral economics and behavioral finance, with deep expertise in saving and investment behavior.
0.4 Book Introduction:#
Following "Thinking, Fast and Slow," this is a comprehensive work in the field of behavioral economics, reflecting on the world from the individual to business and society. Recommended by Daniel Kahneman, Robert Shiller, Malcolm Gladwell, and Howard Marks: a book "that you can't help but continue reading even if you're stuck in an elevator." The English version was released in June 2015 and became a bestseller on The New York Times list, remaining for several weeks. By the end of 2015, the book's international influence continued to expand and spread, appearing on many well-known book lists worldwide. Chinese readers on Douban have given it rave reviews. Wang Shuo, editor-in-chief of Caixin, commented: "When reading this book, I suggest reading it alongside Daniel Kahneman's 'Thinking, Fast and Slow.' Kahneman's book is rich, while Thaler's book is smooth." Kahneman serves as a pioneer of thought, and his "Thinking, Fast and Slow" provides an important fulcrum for understanding ourselves. In this book, Thaler recounts his arduous journey of bringing economics down from the lofty "ivory tower" back to reality, with captivating stories that are not without humor, fundamentally changing our views on economics, ourselves, and the world.
In October 2017, he was awarded the Nobel Prize in Economic Sciences for his contributions to behavioral economics. After the announcement of the award, the Royal Swedish Academy described Thaler's research (not all content) as follows: Richard Thaler incorporates psychological realities into economic decision-making analysis. By exploring the consequences of bounded rationality, social preferences, and lack of self-control, he demonstrates how these personality traits systematically affect individual decisions and market outcomes.
Author's Introduction#
Richard Thaler, the 2017 Nobel Prize winner in Economics, is a pioneer in modern behavioral economics. In 2015, he was elected president of the American Economic Association. Besides "Misbehaving," he co-authored the bestselling book "Nudge" with Cass Sunstein.
Summary of the Book#
Traditional economics assumes that people are rational economic agents, but in reality, people often make irrational choices. Richard Thaler's behavioral economics introduces psychology into the field of economics, providing more accurate predictions of human behavior.
Key Knowledge from the Book#
- Mental Accounting
(1) Transaction Utility: When we judge whether money is well spent, we not only consider whether the item is worth the price but also how much the price deviates from our mental expectations, which is transaction utility. Merchants exploit this by setting high prices and offering discounts to enhance the transaction utility and attract consumers.
(2) Sunk Costs: Any costs already incurred are sunk costs. Rational economic agents do not consider sunk costs when making decisions, but ordinary people are often influenced by them.
(3) Opportunity Costs: The amount of money that can be made from selling something now is its opportunity cost; what else can be done during that time is the opportunity cost of that time. Rational economic agents consider opportunity costs at all times, but ordinary people rarely do.
(4) Money Consistency Principle: Rational economic agents believe all money is the same, but ordinary people unconsciously differentiate, with small change being more easily spent, followed by demand deposits, and time deposits being the hardest to spend. Money won from gambling may be considered "not their own." When facing significant losses, people are more inclined to take greater risks to invest.
- Self-Control and Delayed Consumption
(1) Samuelson's Discounting Model: The utility gained from delayed consumption decreases systematically over time. This model does not reflect reality; a more realistic model should be the hyperbolic model, which simply states that if the first year decreases to 70%, the second year to 63%, the third year and beyond remain at 63%.
(2) After Samuelson, economists increasingly leaned towards using mathematical models to solve economic problems, and their assumed economic agents became increasingly intelligent, considering not only the future year to three years but also a lifetime, with some economists even assuming that people would consider the affairs of their descendants for three generations. Thaler believes these economists' assumptions are meaningless for describing reality and predicting the future.
(3) Dual-System Model: Thaler proposed a model of self-control. It assumes that within a person, there are two selves: a rational planner who cares about the future and has good plans, and an impulsive actor who lives only in the moment. The key issue in this behavioral model is how to describe the relationship between the two selves.
- The Issue of Fairness
(1) Traditional economics starts from a rational perspective, believing that price fluctuations caused by changes in supply and demand are fair. However, ordinary people do not think so. In the eyes of the vast majority, price increases due to supply shortages disrupt established trading habits and are clearly a form of price gouging.
(2) Endowment Effect: Unlike rational economic agents who analyze demand seriously, ordinary people’s perception of fairness is mainly due to the endowment effect. Thaler has demonstrated the existence of the endowment effect through token experiments and mug experiments.
(3) People will punish companies that engage in unfair trading. Traditional economics assumes that people are selfish, but "dictator game" experiments have proven that the vast majority choose to adhere to principles of fairness, while "punishment game" experiments further demonstrate that people are willing to sacrifice certain economic benefits to cooperate with those who adhere to fairness principles.
- Behavioral Phenomena in Finance
For a long time, financial economists believed that abnormal behavior could not occur in financial markets, especially that the classic "efficient market hypothesis" could not be wrong. However, Thaler's research has uncovered anomalies that violate the efficient market hypothesis.
(1) The efficient market hypothesis states that the price of any asset reflects its true intrinsic value, meaning prices are always reasonable. If a company's fair valuation is 100 million, then its market value in the stock market is also 100 million.
Robert Shiller was the first to discover the phenomenon of unreasonable prices, arguing that just as social phenomena can affect fashion trends, they can also influence stock prices.
Thaler found that the efficient market hypothesis has an iron rule: the law of one price, which states that the same asset cannot simultaneously have two different selling prices. However, the reality is that there are many situations in the market that violate the law of one price, such as closed-end funds.
(2) The efficient market hypothesis states that there is no free lunch; we cannot outperform the market. However, there are numerous cases of outperforming the market, the most typical being the value investment principles of investment master Benjamin Graham.
Thaler's research found that stock prices in financial markets also exhibit mean reversion, which is an anomaly that violates the efficient market hypothesis.
Important Points#
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Transaction utility was not first discovered by economists; merchants have long been using this principle to make money off us. Just look at the mall, where some items are constantly discounted. Hair salons often encourage customers to buy membership cards, which allow for discounts, also to enhance transaction utility.
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Rational economic agents do not consider sunk costs when making choices, but ordinary people are influenced by sunk costs. For example, if you paid a high price for a concert ticket, you would still go to the concert even if it was dangerous to do so.
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For ordinary people, while we may not spend a lot of money on a bottle of 1990 Lafite, if we happen to have a bottle of wine we've been saving for years, we probably won't think about selling it. Most likely, we will take it out on a special day and drink it with family or friends.
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Even particularly conservative individuals who are completely unwilling to take risks may impulsively gamble all their money after suffering significant losses. While we rarely gamble, we should note that stocks can sometimes lead people to make similar decisions, which is why the phrase "cut losses in time" is often emphasized.
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Why does the government require everyone to buy pension insurance? Because without compulsion, many people would not arrange their consumption and savings according to plan.
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If we can establish and implement sound rules, life will be better, such as companies paying salaries monthly rather than averaging annual salaries over nine months or even paying once a year.
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Thaler's dual-system model can be compared with Kahneman's fast and slow dual-system model proposed in "Thinking, Fast and Slow." The planner belongs to the slow system that emphasizes reflection and deep thought, while the actor belongs to the fast system characterized by impulse and intuition.
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There is a significant gap between ordinary people's perception of fairness and traditional economists' analysis of fairness. Many traditional economists' notions of fairness are not recognized by ordinary people. Therefore, when companies change their relationships with users, they must consider ordinary people's feelings about fairness; otherwise, they risk incurring losses.
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Ordinary people do not make rational judgments in the stock market but predict based on short-term performance. Ordinary people's attitudes toward stocks can fluctuate erratically, as they are easily influenced by various noises.
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In the face of many anomalies that contradict traditional financial economics, policymakers must not blindly trust market forces but should intervene with policies at appropriate times.
Author: Yejia Xuehui Xiaoming
"Misbehaving: The Making of Behavioral Economics"
Richard Thaler
65 Notes
Recommendation Preface One
2023/2/28 Expressing Thoughts
Every system has its unique charm, with both advantages and disadvantages, just like every choice we make in life. We do not choose the perfect path but rather the one we believe to be better at that moment, considering all factors.
People choose a market economy not because it is perfect, but because there are no better alternatives.
Behavioral economics posits that humans are not purely rational beings but social beings. The decisions people make are influenced not only by economic rationality but also by many psychological factors that are determined collectively. These psychological factors include both rational and many non-rational or self-interested but irrational elements. These psychological factors cannot be expressed numerically and cannot be included in mathematical models. In mathematical models, these unmeasurable and unpredictable factors are represented by random variables, which effectively deny their role in decision-making.
Part One: The Emergence of Behavioral Economics: 1970-1978
From the perspective of rational economic agents, many things are unrelated. Economic agents do not feel hungry while shopping on Sunday and then order a large meal for themselves on Tuesday; the hunger felt on Sunday should have no relation to the meal ordered on Tuesday. Economic agents do not eat all the food they ordered simply because they have already paid for it and do not want to waste it, even if they are not hungry. For economic agents, past expenditures have no relation to how much food they eat now. Economic agents do not expect to receive gifts on anniversaries or birthdays; what makes these days different from others? In fact, economic agents may be perplexed by the issue of gifts. They know that money may be the best gift because it can buy any of the best gifts. However, unless your spouse is an economist, I do not recommend giving money as a gift on your next anniversary. Upon reflection, even if your spouse is an economist, giving money may not be the optimal choice.
At the same time, we will provide some useful methods to teach you how to change the way people think, especially when they strive to maintain the status quo.
2023/2/28 Expressing Thoughts
Dialectical self-deprecating humor
When you feel it is no longer interesting, stop reading; otherwise, it will be what is called "misbehaving."
Simon proposed that human rationality is limited, meaning people lack the cognitive ability to solve complex problems, which is evidently correct.
Bernoulli proposed the idea of "risk aversion" because he believed that people's happiness, or what economists call "utility," increases with wealth but at a decreasing rate. This principle is known as "diminishing sensitivity," meaning that as wealth increases, the impact of a certain amount of increment (such as $100,000) will diminish.
2023/3/1 Expressing Thoughts
Just noticeable difference.
Psychologists refer to the barely noticeable difference as "just noticeable difference" (JND).
2023/3/1 Expressing Thoughts
This short chapter by Richard Thaler helped me clarify the connections between loss aversion, endowment effect, and prospect theory. I really like his way of expressing ideas: simple, humorous, and logically clear, making it much more enjoyable to read than "Thinking, Fast and Slow," although this may also be related to the translation.
Therefore, we experience life through changes, and our sensitivity to losses and gains follows a diminishing pattern, with the pain caused by losses exceeding the pleasure brought by equivalent gains.
Slow inspiration is not the kind of sudden enlightenment where everything becomes clear, but rather a vague impression that something interesting is happening; it is also an intuition that the arrival of important moments is not far away.
The two core concepts of economics have remained unchanged: one is that economic agents pursue optimization; the other is that markets reach equilibrium.
A profit-maximizing company will set production and pricing when marginal costs equal marginal revenues.
Because learning requires continuous practice, we may do better in small matters. In other words, critics must think carefully about which arguments to use. If learning is important, then as benefits increase, the quality of decision-making will gradually decline.
Part Two: Mental Accounting: 1979-1985
I have identified two types of utility: "acquisition utility" and "transaction utility." Acquisition utility is derived from standard economic theory, equivalent to what economists call "consumer surplus." Consumer surplus refers to the utility brought by an item minus the opportunity cost that must be given up.
Transaction utility refers to the difference between the actual price paid and the "reference price," where the reference price is the consumer's expected price.
Even wealthy consumers want to derive great pleasure from transaction utility.
If money has already been spent and cannot be recovered, that money is a sunk cost, meaning it is a lost cost. Expressions like "spilled water" and "past mistakes are not to be blamed" are some of the phrases economists suggest we ignore sunk costs.
"Payment depreciation" means that the effect of sunk costs decreases over time.
Mental accounting operates this way: the initial expenditure is viewed as an investment (rather than a purchase), and the annual "maintenance costs" are annoying, but future vacations here are "free."
2023/3/5 Expressing Thoughts
Reverse thinking and understanding cycles and human nature can effectively reduce the "house money" effect.
It is precisely the "house money" effect, along with the tendency to use recent gains to speculate on future gains, that leads to the creation of economic bubbles.
Summary of "Misbehaving: The Making of Behavioral Economics"#
Richard Thaler's "Misbehaving" is a comprehensive exploration of behavioral economics, emphasizing the irrational behaviors that often contradict traditional economic theories. Through engaging anecdotes and rigorous analysis, Thaler illustrates how psychological factors influence economic decision-making, ultimately challenging the notion of the rational economic agent. The book serves as both an introduction to behavioral economics and a reflection on Thaler's contributions to the field, making it a valuable resource for anyone interested in understanding the complexities of human behavior in economic contexts.