An abbreviated summary of both the lectures and the accompanying clips for the human decision making course. This summary discusses many theories about people's decisions. People are systematically deviating from the rational, so theories can be written about this. This course talks about both indi...
General decision making - Introduction
Rational decision making
Economists think people make rational decisions. The rational decision making process looks like this:
1. Gather information
2. Evaluation
3. Action: deciding/choosing
4. Implementation: executing the decision
5. Evaluation of the outcome
Judgement vs problem solving:
Judgement: cognitive part of decision making, part that comes before making a decision.
Picking one of the options
Problem solving: looks like decision making, only it not necessarily requires action
Nowadays we know that rational decision making is not possible in a lot of situations and that
behavioural economics studies deviations from this rational model.
At least: economics think it can be seen as deviations from a model and still be the same
theory
o Psychology makes new theories about the deviations from a model
Bounded rationality
For the rest of the course, people focus on bounded rationality: people don’t have all the
information to be rational and therefore use simplified models and heuristics to make a choice
Intertemporal decision making: making decisions over time. This is present in almost every domain
in life. For example eating behaviour: choosing in the supermarket what you will eat in a week.
Discounting
Discounting: the valuation of future outcomes relative to present outcomes.
In other words: the weight you give to different outcomes depending on when they will come to
effect. For example: how much would are you willing to give to receive something now instead of in a
week?
Measured with discount rate (dr), where a higher rate indicates more impatience.
Models of discounting
Exponential discounting: way you should discount according to economic rational model.
Constant discount rate over time
So if the amount of time doubles, the discount rate doubles too.
Hyperbolic discounting: most realistic model, used by people a lot.
High discount rate in near future, lower discount rate in the distant future
Leads to:
o Preference for smaller-sooner (SS) over larger-later (LL)
People prefer 50 euros now over 100 euros in a year
o Dynamic inconsistency: choices that you make depend on the length of the delay
there is until these choices come into effect.
o Preference reversal: now you prefer A, later you might prefer B
, Deviation
Hyperbolic discounting is a way in which people deviate from the standard way of discounting. This
leads to:
Suboptimal outcomes (according to rational model)
Satisfactory outcomes (according to reality)
Types of deviating
Delay effect: lower discount rates for longer delays.
o Study: 15 dollars now or..?
20 in a month (dr 345%)
100 in 10 years (dr 19%)
Magnitude effect: higher discount rates for smaller amounts
o Study:
15 dollars now equals 30 in 3 months (dr 277%)
3000 dollars now equals 3500 in 3 months (dr 62%)
Sign effect: higher discount rates for gains than for losses
o Remember 15 dollars now was 30 in 3 months (dr 277%)
o But if people got a fine (15 dollars), which they had to pay now or in a month, they
would want to pay only 1 euro extra (dr 26%)
Direction effect: higher rates for increased delays dan decreased delays
o Study: 100 dollar gift card
Delay premium: Now or 6 months, people wanted 26 dollars extra for 6
months
Speed-up premium: 6 months or now, people willing to pay 10 dollars for
now
Sequence effect: increased sequences are preferred over decreased sequences. Increasing or
decreasing salary? End salary is the same in both options. People prefer increasing.
o Savouring vs dread
Willingness to delay a pleasurable outcome
Willingness to speed-up a painful outcome
Interval effect: higher discount rates for shorter intervals
o People give higher discount rates to three interval periods of 8 months than 1 period
of 24 months
Between these effects, there is a lot of interaction
Measuring discount rates
Almost all of the effects above are time trade-off measures
o Giving options between smaller sooner and larger later rewards
o Option to do it incentivized or non-incentivized: get the money you choose or
hypothetical situation
Other way to measure: inferring instead of measuring. The researcher infers instead of really
measuring it.
o Can be done from behaviour: someone buying a cheap energy consuming dryer of an
expensive energy sustainable. Both cost the same in the end, but a researcher can
infer from this choice what a person wants when discounting
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