When thinking of and acting upon decisions, we tend to “misbehave” as the logic behind these decisions aren’t congruent with each other as Richard Thaler, professor of behavioral science and economics at the University of Chicago Booth School of Business, discuses in the book. He uses several anecdotes and studies from throughout his career to present this case. An example was when he presented these scenarios:
Scenario A: You go to the store to buy a clock radio for $45. You’re then told by the cashier that if you were to walk 10 minutes down the street that you’d be able to save $10 on the same set of speakers.
Scenario B: You go to the store to buy a television for $495. You’re then told by the cashier that if you were to walk 10 minutes down the street that you’d be able to save $10 on the same set of speakers.
When analyzing and comparing the responses, he found out that a greater number of people would walk the 10 minutes to save the $10 in scenario A than in B. Thaler argues that this is “misbehaving” from a behavioral economics standpoint. Some of the points taken away from this book are:
1. When it comes to making “investment” decisions, find the expected reward against the risk. This can easily be done mathematically by multiplying the associated probabilities by the outcomes. An example would be when deciding to take on a project that will cost you (risk) $100,000 but that can potentially reap in a benefit of $1,000,000 (reward). The probability of you making the $1,000,000 is 20%. Essentially the expected reward is $200,000 ($1,000,000 x 20%) which is greater than the risk of $100,000 and therefore the project should be taken on. In decisions involving risk and return, a simple general calculation of expected return can be done.
2. When deciding on something, make sure that the marginal benefit of that act is at least greater than the marginal cost; this isn’t just for money, but also for time. Example, you hire an employee and pay them $10/hour and they bring in $20 in income/hour. You hire another employee for $10/hour but they bring in only $15 in income/hour. You hire another employee for $10/hour but they only bring in $10/hour in income. Following this trend, it wouldn’t make sense to hire an additional employee for $10/hour assuming that they’ll only bring in $5/hour in income.
3. Learn to understand opportunity costs. In everything that you do, there’s an opportunity cost to doing it, both financially and with your time. When making decisions, think about what can do instead with that time and or money. The example given was when one of his colleagues bought a bottle of wine a while ago for $10. His coworker then said that he’d be willing to purchase that bottle for $100 off of him. He said he wouldn’t sell it because he wanted to for himself for special occasions. He also stated that he wouldn’t spend $100 on a bottle of wine. He essentially bought that bottle of wine for $100 as soon as he had turned down the offer.
By Ryan Lee
Check out the book here: