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Samenvatting colleges Economic Psychology TiU (2023/2024)
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This document includes all material covered in the Economic Psychology lectures (2023/2024) given by Marcel Zeelenberg at TiU.
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InhoudsopgaveEconomic psychology..................................................................................................................................... 1
Lecture 1: Introduction & course set-up...............................................................................................................1
Lecture 2: A little history of economic psychology...............................................................................................1
Lecture 3: more formal models of decision making: expected value & expected utility......................................5
Lecture 4: prospect theory and beyond................................................................................................................7
Lecture 6: Mental accounting & reason-based choice.......................................................................................11
Lecture 7 Choice and time..................................................................................................................................15
Lecture 8: emotions and economic behavior.....................................................................................................17
Lecture 9: Self-interest and beyond...................................................................................................................21
Lecture 10: Fairness............................................................................................................................................24
Lecture: 11 Maximization and greed.................................................................................................................27
Lecture 12: immorality.......................................................................................................................................30
Lecture 13: Doing economic psychology............................................................................................................34
Lecture 14 practice exam...................................................................................................................................37
Economic psychology
Lecture 1: Introduction & course set-up
Lecture 2: A little history of economic psychology
Psychological principles
1) Many choices are automatic.
2) People are social animals.
3) People respond to mental models.
4) People are hard to mobilize.
5) Small changes can have big effects. (-> example of New York, where
cars were introduced to reduce the smell of horse shit on the streets,
something that now isn’t associated with clean air)
Rewards and punishments may be counterproductive.
- Cobra effect: Brits wanted to reduce cobras in India, so they gave a
bounty for every cobra skin, but people started making more cobras
to make money. (Similar to the French in Vietnam, where people
chopped of only the rat’s tail.)
- Gneezy and Rustichini, 2000: gave fines for picking up children at
daycare late after 5 weeks. As a result, the number of times people
were late increased, because now they had an excuse for being late.
Different behavior than expected, so always test your intervention.
Importance of testing was also shown in an intervention for teen
pregnancies that made girls care for a doll. They liked it (because they
often were lonely), so they had babies when the dolls were taken away.
,Economy started with philosopher Adam Smith. He wrote wealth of nations
in 1776 where he wrote about organizing society. He believed in a rational
economic man with self-interest and the invisible hand; economy will sort
itself out if you leave it alone, because people look for the most valuable
jobs and people work for their own benefit.
In his earlier writing “moral sentiments” (1759) Adam says the
opposite. He talks about how people will sometimes do things not for
their own benefit, but because it makes them happy to see others
happy (social utility). He proposes an act of sympathy in which
through observing people become aware of the morality of their own
behavior. He suggests that conscience arises from social
relationships.
Empathy-induced altruism: people can be altruistic if they feel
sympathy or empathize with someone.
Blaise Pascal (mathematician, 1623-1662) came up with expected value;
the possibility of getting something and how much it is, EV = p*x.
Psychology is concerned with the issue of choice and decision making.
St. Petersburg paradox & utility by Daniel Bernoulli and Nicolas Bernoulli is
about why people gamble. People accept risks based on the possible
losses or gains and the utility. The marginal value of money decreases as
one’s wealth rises.
Jeremy Bentham (1748-1832); rich guy that also wrote about the
organization of society. Worked in London and when he died donated his
entire library to the university on the condition that he would be in the
university board forever. So, he got embalmed and is wheeled out for
every meeting. If the votes are equal his vote always goes to the
progressive option. He thought it was a shame that knowledgeable/smart
people died because they couldn’t give lectures anymore. He also was in
favor of taxing the rich and giving it to the poor because it would overall
generate more happiness.
Example of ideas about society is the panopticon prison; round
prison with a tower in the middle, so only one guard was needed,
and a curtain so prisoners didn’t know if there even was a guard.
Jeremy realized a society without criminals couldn’t exist, so the
society had to “punish” them as cheap as possible.
Came up with the principle of hedonic calculus -> the sum of hedons
(units of pleasure) and dolors (units of pain) to make a decision. In
order to maximize, we should quantify and compare pleasure of
possible acts.
John Stuart Mill (1806-1873); utility/the greatest happiness principle
means that actions are right if they proportionally promote happiness
(intended pleasure and absence of pain) and wrong if they produce the
opposite of happiness (pain and deprivation of pleasure).
,Carl Menger (1840-1921) was the founder of the Austrian school of
economics and developed a more complicated version of Maslows pyramid
of hierarchy.
John Maurice Clark (1884-1963) wrote two articles: economics and modern
psychology 1 and 2. These where about how the two principles influenced
eachother and how economics is a behavioral science. Point where
economics and psychology went different ways.
- Economics became more mathematical; mathematical models and
testing them with data. Predictive value of the theory mattered, not
the plausibility; called the f-twist.
- Psychology became more experimental; artificial conditions in a
lab, control of variables, participant recruitment.
Economy has anomalies from a theory and psychology has a separate
theory for every anomaly.
George Katona (1901-1981) is the prototypical economic psychologist. His
biggest invention was the index of consumer sentiments, which was a
good predictor of how the economy develops.
Assesed by asking people if they plan to spend money on a big
purchase in the upcoming weeks, if they think it’s bad timing, they
will say no. turns out that individual choice determines what
happens with the economy, because they add up. Less trust in the
market means less spending. (consumentenvertrouwen vs
consumentenuitgaven)
Ward Edwards (1927-2005) brought economy and psychology back
together after the diversion. Herbert Simon, Daniel Kahneman and Richard
H. Thaler got a Nobel prize for their work by also doing this.
- Simon (Nobel prize in 1978):
o Bounded rationality: economy assumes rationality, but we
know from psychology that people have limited cognitive
capacity to make these calculations. They are motivated to be
rational within the limit of their cognition.
o Satisfycing: people choose something that is “good enough”,
but maybe not the best, and will switch when something
better comes along.
- Kahneman (Nobel prize in 2002):
o Researched probabilities and risk judgement, how people
decide the p in EV. His conclusion was that people use
heuristics and biases in judgement.
- Thaler (Nobel prize in 2017):
o Introduced mental accounting; we have mental systems that
keep track of our finances.
o Fairness doesn’t exist in economics, but it does in humans.
Assumptions of economic theory
- Stable preferences (over time and situations)
- Self-interest
, - Maximization (greed)
- No cognitive limitations
- Unlimited will-power
- Complete information (market transparency and asymmetrical
information)
- Long time perspective
No role for emotion or fairness
Carmerer & Loewenstein: “at the core of behavioral economics is the
conviction that increasing realism of the psychological
underpinnings of economics analysis will improve the field of
economics.”
o So, looking at the assumptions and determining if they are
true or not and defining how people behave should give better
(theoretical) insight, predictions and policy making.
Economists’ arguments versus psychologist rebuttals
- People may not be rational, but they act rationally -> not true, there
are many instances of irrational behavior.
- Irrational agents will become extinct -> not true, if you don’t know
your preferences incentives will influence you. And every time this
happens when someone sells you something there is a money
pump.
- Aggregate behavior is more rational (errors in rational behavior
cancel out with rational behavior)-> there are systematic deviations.
- In the real world people will get it right (an experiment differs from
the real world). -> not true because of systematic deviations and
overconfidence
- If the stakes are high enough, people will get it right (a lot of studies
are about small money decisions, but people will be more rational
when studies are about higher amounts of money) -> not true,
because small money decisions add up.
But what is rationality = when people decide what to do, they look at what
it gives them, and how likely it is that they get it. EV = likelihood of gain *
value of that gain
Where does it go wrong?
Likelihood of gain side
- Biased probability estimations: people can’t properly estimate p.
- Availability heuristics: how often instances come to mind. For
example more people drown in a year, but the news covers terrorist
attacks, so you think they happen more often. Or in a casino a
winning machine makes a sound, but a losing one doesn’t so you
think your probability of winning is bigger than it actually is.
- Cognitive heuristics: short-cuts or rules of thumb for a probability or
freqence estimate.
- Representativeness heuristics and the base-rate fallacy: if someone
is representative of a group of philosophy students you would
assume that they are part of that group. But, there are a lot more
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