behavioral economics – Page 2

February 21, 2018March 29, 2018

Episode 5: Consumers overvalue what they have, and that’s a problem.

Another derivative of what I call “ownership bias” is the difference between the willingness to accept money (WTA) and the willingness to pay money (WTP).

People exhibit ownership bias when there is something that they feel is theirs; that they own.

Let me take you on a quick mind-journey.

Your grandfather carefully cut, planed, jointed, and hand sanded a desk. He stained the wood by hand himself. He specifically picked white oak because of its beauty and desire for it to be enjoyed for generations to come. It’s perfect in every way. Solid, friendly, worn yet warm. Just like your grandpa.

Let me pop your mind-bubble. It’s worth about $250 in market value. It’s a worn, decently crafted, brown hardwood desk. Maybe it’s worth even less. Maybe $150. I’d probably lowball you for about $75. You would never part with such a treasured family item. That’s ownership bias.

What’s interesting is that this can happen on a much smaller scale, even as small as “gifting” you a pen. We’ll talk a lot more about ownership bias later, so I don’t want to get too carried away (it’s so fun though)!

Ownership bias is the first half of the willingness to accept/willingness to pay divide (spoiler!).

The second half is fear of loss. Your old brain is afraid of losing resources. It yells at you to hoard, to not lose what you have.

When someone offers us money (which is basically an abstract construct), for something physical we have in our hand, we often overestimate the value of the thing in our hand because we don’t want to lose it.

Mash those two concepts together and what you get is this gap between the WTA and the WTP. To measure this, the typical experiment goes like this:

Half of the subjects are given an item, and then offered money to return it (willingness to accept).

Half of the subjects are asked to pay for the item (willingness to pay).

Researchers make a ratio (two numbers divided by each other) out of these, with WTA on the top (because it’s usually bigger), and WTP on the bottom. AKA, WTA/WTP.

For example, if your willingness to accept a deal for my grandfather’s desk is $600, but my willingness to pay is $200, the WTA/WTP ratio is 600/200 or 3:1 (aka, 3).

I won’t bore you with the details of a thousand studies about WTA and WTP. Fortunately, in A Review of WTA/WTP Studies Horowitz and McConnell did this for us! Thanks for that.

Beyond the fact that WTA is almost always higher than WTP for the reasons noted above, let me give you one more smart tid-bit that the researchers discovered, and I quote from the study:

“We find that the farther a good is from being an “ordinary private good”, the higher the ratio”.

So, the MORE unique an item is, the HIGHER the ratio between the willingness to accept (WTA) and the willingness to pay (WTP) is. The researchers found that non-ordinary goods have ratios that are usually about 6-8 points higher.

This makes sense. The imbalance between the willingness to accept and the willingness to pay is because when we own something we overvalue its worth to other people.

The more unique and special it is to us the higher we as humans will overvalue that product. You’re going to proportionally overvalue your grandfather’s desk far more than a cup of regular uncooked white rice (which is the most ordinary good I can imagine).

Let’s talk about real world practicality.

If you are in an industry that buys anything from consumers, you should understand that consumers will almost always overvalue what they have. It will cause them to be uncooperative in the face of reasonable market value deals.

Or, say, in the insurance world a customer would feel cheated because their grandfather’s desk was replaced by market value. They will feel as if the insurance company stiffed them even though that is not the case.

And conversely, if you want to make your customers feel like they have been given something valuable, give them something special they can own and treasure.

Horowitz, J. K., & McConnell, K. E. (2002). A Review of WTA/WTP Studies. Journal of Environmental Economics and Management, 44(3), 426-447. doi:10.1006/jeem.2001.1215

February 6, 2018March 29, 2018

Episode 4: How trying to avoid regret changes our behavior

Let’s talk about regret aversion. Again, fancy phrase, simple idea. Let’s go on a mind-journey!

Imagine this.

You’re at home cleaning out an old shoe box of junk. I mean, you’ve had this stuff forever since you were a kid. But do you really need that candy bar from 17 years ago that you’ve been keeping just to “see what happened in 10 years?” No. No you don’t.

You’re rifling through your items while sitting on the floor, and sifting things into keep or trash piles. Suddenly you spot under some papers a small pack of NBA basketball cards held together with a rubber band. Man! You’d forgotten that your uncle used to buy you these as a bribery present so you’d like him whenever he came to visit.

You did really like them though, so bribe accepted. You ponder that maybe you should be bribing your own nieces and nephews more. Nodding your head as you have learned another lesson about adulting, you pop the rubber band off and take a look to see what you’ve got. Boring. Retired. Meh. OH WOW! It’s a rookie Shaq card. What a find!

You of course know from your great NBA knowledge that Shaq exploded onto the NBA as a rookie, averaging 23 and 14 and instantly dragging the Orlando Magic into the realm of interestingness, only to leave for the Lakers like everyone else, casting Orlando back into uninterestingness until the disaster that was Dwight Howard a decade later.

But this card is worth money. You do some quick research online and find out that this card is actually part of a famous run by a famous brand, is really rare, and in very high demand. You get in touch with a dealer and you negotiate him up to $1,200 for the card. You’re worried you can get a better deal, but there’s no point in holding on to the card. And hey! You forgot you had it, it’s like finding a free $1200 right? It seems like a fair deal.

Full of confidence you pull the trigger and make the deal.

You get the deposit in your Paypal account and spend it to pay down some credit card debt. Sighhh. Life.

Not two weeks later you’re checking out the news on your favorite site and there’s a breaking news alert! OMG! Shaq tragically just passed away far too young. You can’t believe it and neither can anyone else. Memorials are held. Jerseys re-retired (and re-released), and memorabilia sales explode.

With baited breath you terrifyingly check the dealer’s website a few weeks later out of dread, and sure enough, there’s YOUR card, being resold by the dealer for over $13,000.

Gulp.

“Why did I sell that stupid thing! Ugh I knew I should have held onto it. I could have made so much money!” You feel pangs of regret, and have trouble relaxing for a day or two until you go to the gym a few times and play some video games to get it out of your system and let it go.

You have to stop watching all the Shaq memorial coverage. Too many bad memories about your card and what could have been (money).

So that’s regret. Regret aversion is simply the fear of this situation. It makes us doubt and second guess ourselves. We try really hard to avoid these feelings of regret (that’s the aversion part). There many types of regret, and some types of regret are stronger than others.

A study done by Seiler, Seiler, Traub and Harrison called “Regret aversion and false reference points in residential real estate” tried to test for regret aversion. They did so with simple questions where subjects were asked to assess their regret on a scale of 1 to 9, with 1 being low, and 9 a high level of regret.

The hypothetical situation the subjects were given was that they “purchased” a home for $200k five years ago. Today it’s worth $300k. That’s great news, right? There were two conditions, with half the people in each.

The first condition is “omission”. In the “omission” condition the participants find out that two years ago they could have sold the house for $350k, but were not aware of the potential sale at the time.

The second condition is “commission”. In the “commission” condition they knew two years ago that they could have sold the house for $350k, but believed the price would keep going up and did not pull the trigger.

In both conditions they still made the same amount of money ($100k). Their happiness with the sale should be the same, right?

Well, overall, people in the “commission” condition who could have sold the house, but chose not to, had statistically significant higher levels of regret than those in the “omission” condition who were unaware of a potential sale (4.69 regret vs. 5.08 with knowledge).

The bottom line is that people feel more regret when they lost something but feel like they had the control to make a different decision.

To a certain extent this is part of the fear of loss which I will talk about a lot more. But fear of loss manifests in many different ways, and this is just one of them.

Even though the end result is the same, learning that we could have made more money, but that we messed up, made a mistake, and sold at the wrong time, feels worse.

If we had no control over the situation and did not know that we had the option to sell the house at a higher price, then we can shrug and say “It was fate. I’m not responsible; Jesus take the wheel.”

It’s an act of god and out of our hands, we never lost what we could never have achieved. But when we had it in our hands, but then lost it because of our own mistakes; that’s troubling.

When we mess up we feel regret aversion. The next time we have to make a decision, we don’t want to make any decision. We freeze because we’re scared of making the wrong choice. Of selling a week too soon, or a day too late.

Like everything else in the 100, this is one of those peculiarities that causes us humans to make decisions and choices that are not the most logical or predicted by a computer. It’s not a simple sum choice utility function. It’s complex weird primate brains.

So let’s talk real world implications.

You can drive action by stimulating people’s fear of loss. Businesses do this all the time (the deal ends in 4 hours! better buy now).

For example, if you want to make people more cautious about selling stocks, send them alerts about all the times they could have sold their stocks for more money, but now it’s worth less. This strategy might actually cause them to switch partners, so maybe it’s something to avoid, but it certainly would stimulate a fear of loss.

Giving people information, so they have the decision in their hands, and then mess it up, will stimulate more regret aversion. It’s certainly a tool in your arsenal that you should consider using when needed.

Give it a try! Did you find any difference? This is an especially tricky one to test because it is so specific, and also occurs over a period of time. But it’s fascinating to discuss.

Seiler, M., Seiler, V., Traub, S., & Harrison, D. (2008). Regret aversion and false reference points in residential real estate. Journal of Real Estate Research, 30(4), 461–474.

January 19, 2018March 29, 2018

Episode 3: Why something being FREE is so compelling

Everyone loves free. There’s something truly magical about getting something that you value for free and the feeling seems universal.

In another post I’ll talk about why we feel indebted when we get something for free, but for now, I want to focus on the feeling of free. If we want it; we take it. It’s almost like a compulsion; a quick little burst of joy like the pure thought of a child. Here is a thing I wish to possess, and with no effort at all, I simply can possess it. Pure joy. Let me take you on a mind-journey to that feeling.

Imagine I walk up to your desk right now and place in front of you a delicate piece of your favorite candied dessert in the entire world, carefully wrapped in a small square of brown paper wrapper. It sits there perfectly. You reach down, pick it up, and eat it, savoring every second. Is it indulgent chocolate? Smooth and silky dairy crème? Lush strawberry? Fluffy sponge cake?

I encourage you to rate your feelings of joy on a scale of 1-10. Now clear your mind of that fun escape. Picture a paper clip on some sand. Okay, clear? Let’s go on another mind journey.

Imagine I walk up to your desk right now and place in front of you a delicate piece of your favorite candy in the entire world, carefully wrapped in a small square of brown paper wrapper. It sits there perfectly. I look at you and say: “Hi, I am selling this piece of candy. It’s small so I’m going to charge you $.01. If you’d like to purchase it, I only take cash. However, I see that you have a small stack of pennies on your desk so change should be no problem. Would you like to purchase it?”

Think about your decision. Would you pay a penny for the candy? How are you feeling? Are you feeling joy? Even if you did decide to purchase the candy and eat it, which would be amazing, I bet the feeling of pure joy about the transaction was lost or at least greatly diminished. If there was joy it felt different somehow. It was less pure joy and more the happiness and satisfaction of getting a good deal.

To us humans, free feels different somehow, and sure enough, it causes us to act differently too.

In Zero as a Special Price: The True Value of Free Products, a research paper by Shampanier, Mazar, and Ariely, the researchers explored different people’s reaction to encountering free with a series of clever experiments.

Subjects were given a choice between two pieces of chocolate. One was “cheap” (Hershey’s), the other was “expensive” (Lindt or Ferrero Rocher). The experimenters played around with offering different prices to different people. Importantly, the expensive chocolate was always exactly more ($.25 more in the first experiment) than the cheap offering.

Here are the results:

The column on the left entitled “2 & 27” shows what happened when the researchers set the prices at $.02 for the Hershey’s bar and $.27 for the Ferrero Rocher. 45% chose the cheaper Hershey’s, 40% chose the more expensive Ferrero, and 15% chose nothing.

The column in the middle has the results for when the prices were $.01, and $.26. The results are about the same with a little bit of variance which is expected. The difference in price is still $.25 between the two candies.

The column on the right entitled “0 & 25” is the free condition (free and $.25). There is a huge shift when the price was free. 90% went with the free option and only 10% went for the Ferrero.

But there should be no difference between the different prices! You’re paying $.25 more for the expensive candy in any of the three conditions, and yet way more people choose the cheap candy when it is free vs. $.01. Somehow making it free makes it more valuable or desirable.

But what about transaction costs you might ask? Maybe people like free because the $.01 condition has a hidden cost; the cost of the transaction itself (aka, the pain and hassle of paying).

The researchers smartly accounted for this. They set up a real-world experiment where the chocolate choice was made at the checkout of a cafeteria. Everyone was already going to swipe their credit card. As you can see, there are similar results (although more people in the real world choose neither).

The left column entitled “1 & 14” is the condition when both the Hershey’s and Lindt (this time) candies were not free ($.01 and $.14 respectively for a $.13 difference). Only 8% chose the cheap Hershey’s option, and 30% chose the expensive Lindt option.

The right column entitled “0 & 13” is the free condition. Again, the difference between the expensive and cheap candies is $.13. But once the cheap product is free there a huge increase in the percentage of people who choose the free candy over the more expensive candy.

In sum, in real world tests after accounting for transaction costs, the “value” of making something free is a +387% increase in sales of the free product (8% to 31% of marketshare), and a -230% decrease in sales of its competitor (30% to 13%).

So, let’s talk about some real-world implications. Do you need to destroy the subjective value of a competitor’s offering? Do you need to get a foothold in a market? Use free. And it may seem intuitive, but there’s a good reason why.

The leading theory (which is not yet proven, but makes sense) is that there is a brain science reason behind this. When you present a brain with a buy/not buy decision the brain lights up with activity. There are certain pathways in the brain that evaluate decision factors, determine preferences, and decide if you should make the purchase. Even at $.01 the neural pathways are activated in the same way as if you buy a more expensive item.

But at truly free, the brain uses an entirely different neural pathway. Instead of the “buy” neural pathway, it takes a deeper (mid-brain) pathway that involves feelings and emotions. These pathways determine if you want the item instead of if the item is valuable enough to justify a purchase.

Emotional pathways are processed more quickly. The quicker process feels like the right decision, and is easier to make, making you feel better about it.

Perhaps the “want/not want” pathways are emotionally stronger because the decision is being processed literally closer in the brain to where emotions are processed (mid-brain).

Or perhaps going through a value based buy decision drags up negative emotions because of the sadness of spending money.

Regardless of the reason, the theory is that because free is a different neurological pathway, it feels better and more valuable. Therefore, far more people choose the free item.

Thinking is hard and humans really hate doing it.

Have you seen this effect at work in your own projects? If not try it and see what happens. Again, make sure it is truly free otherwise your mileage may vary.

For example, having a price of 0, but requiring that users fill out their contact information isn’t really free. Other transactional “work” can dampen the effect. Give it a try!

Cite:

Shampanier, K., Mazar, N., & Ariely, D. (2007). Zero as a Special Price: The True Value of Free Products. Marketing Science, 26(6), 742-757. doi:10.1287/mksc.1060.0254

January 8, 2018March 29, 2018

Episode 2: What is Behavioral Economics? Part 2

This is sort of a Part 2 of the introduction. I talk about the basic setup of Behavioral Economics, what it is, and basic terms. I’ll get back to a nice long blog post next time! But enjoy this video for now.

As proof of my bona fides I attach these notes from my masters level labor economics class. Math math math math. Also I’m sorry for my terrible handwriting :(

Thanks,
Guthrie

December 18, 2017March 29, 2018

Episode 1: What Is Behavioral Economics? Part 1

Hello friends,

I am planning on embarking on an epic quest, and I want you to come with me on my journey.

Have you heard of behavioral economics? It’s a very fun, interesting field of research that combines decision making, social behavior, and brain science with our everyday human actions.

I’ve been exploring the topic in-depth, and I want to bring you along to share my findings. The purpose of it all is to de-mystify why we humans do what we do. That, after all, really is the point of economics (that and lots of math).

I’ve found 100 Things That Behavioral Economics Can Tell Us About People. How you may ask? I’ve read the research papers. And not the fun “pop-sciencey” articles and books that famous behavioral economists have written. No! I’ve read the research papers behind the books. Hundreds of research papers. I’ve poured over data, figures, tables, and P, R, and T values.

From that wealth of knowledge, I collated, consolidated, and extracted the important (and statistically significant) takeaways from the research. As of this writing it’s 26481 words on 114 pages of research notes alone. And that’s just my notes; I’m just starting now to write this up in a format that you, the readers, can understand without your eyes glazing over in an econometric fog.

Some of the research is about brain mechanisms of behavior. But because we are still in the early stages of being able to see what is actually going on in the brain, most of the studies use the tried and true method of live experiments in the real world to describe and explain the sometimes strange behavior and choices we humans make.

Some of the research results are intuitive, but deserve exploring an answer as to why they are true. Some of the results are not intuitive and make us humans seem stupid. They deserve exploring an answer as well.

Finally, there are big questions about human society and the impact that behavioral economics has on it. Hopefully there are some answers that will provide clarity to those big questions as well.

To help guide you I’ll be using what I call “mind-journeys”. These are detailed narrations, where you can put yourself in the shoes of the person making a decision to help explain these complex topics.

It is going to be so fun! I hope you’ll join me. I hope I can make it to my goal of 100 things. I hope you find the information useful, and fascinating, and maybe it will explain us humans just a little bit more.

Thanks,

Guthrie Weinschenk

February 25, 2017February 25, 2019

Rating Your Projects A- Vs A+

In the last blog post Guthrie Weinschenk explained his idea about saving time and money by rating your projects before you start them. In this podcast Susan and Guthrie discuss how this works and why it works.

HumanTech is a podcast at the intersection of humans, brain science, and technology. Your hosts Guthrie and Dr. Susan Weinschenk explore how behavioral and brain science affects our technologies and how technologies affect our brains.

You can subscribe to the HumanTech podcast through iTunes, Stitcher, or where ever you listen to podcasts.

February 16, 2017February 25, 2019

Behavioral Science vs. Behavioral Economics

What is behavioral science? How is it different from behavioral economics? And why are both so cool? Plus, Guthrie geeks out about Daniel Kahneman’s research.

You can subscribe to the HumanTech podcast through iTunes, Stitcher, or where ever you listen to podcasts.