Social Education 83(2), p. 94–99 ©2019 National Council for the Social Studies Making Economics Cool Econs vs. Humans: An Introduction to Behavioral Economics

M. Scott Niederjohn and Kim Holder

Can teachers promote true economic understanding among students by adding a economics, however, takes investigation dose of psychology? Fans of behavioral economics, with its unique blend of psychol- into human nature further and focuses ogy and economics, think so. Blending a bit of behavioral economics into social on areas in which they are particularly studies lessons provides answers to the ever-present questions that permeate every challenged in making good decisions. classroom,“What does this have to do with me?” and “When will I ever use this?” The results of these experiments have Teachers can help students understand behavior in the world that surrounds us by led to a number of real-world insights moving them from a rote understanding of economic theory to a richer approach that into public policy, business, education, brings in elements of psychology. healthcare and many other aspects of life.

Students exposed to behavioral eco- are credited with originating behavioral Econs vs. Humans nomics find it appealing because it economics with human behavior stud- One simple way to think about behav- allows them to go beyond traditional ies in the 1960s.2 Their work over the ioral economics is to consider how actual economic models. In the traditional eco- next 30 years helped lead to a field that people differ from those modeled in a nomic approach, frequently referred to has directly or indirectly produced six standard economics textbook. One as rational choice theory, basic assump- recent Nobel Prizes in economic science, might argue that the field of econom- tions about human behavior are used to including the 2002 prize to Kahneman ics looks at people as “econs”—that is, simplify the model of how an economy and the 2017 award to Richard Thaler, they assume we carefully weigh costs and works. In contrast, behavioral economics the author of the popular book Nudge.3 benefits of alternatives before making uses assumptions that are more closely In his Nobel Laureate address Thaler decisions. Econs, therefore, could be aligned with how people actually behave. stated, “In order to do good economics, described as being analytical, reflective, The authenticity of behavioral eco- you have to keep in mind that people are effortful, deliberate and patient. To be nomics resonates well with the current human.” This quotation helps explain fully rational, an econ would also need generation and helps students see how the insights that can be gleaned from this to be well-versed in probability theory economic analysis, augmented with psy- field of economic study. and rational optimization. Thus an econ chological insights, can provide genuine Frequently relying on experiments, would always make the best choice given solutions to real world problems. behavioral economics points out that a set of alternatives. Does this sound like humans are not always perfectly ratio- most people you know or interact with? What is Behavioral Economics? nal decision makers. While the field of Behavioral economists don’t think so The field of economics traces its roots to economics has always understood this either. They instead think of humans as Adam Smith’s seminal work from 1776, fact, the discipline does rest on the using costs and benefits, but also being An Inquiry into the Nature and Causes idea that people can accurately weigh influenced by other factors when mak- of the Wealth of Nations.1 In contrast, costs and benefits to make decisions ing decisions. Humans might sometimes the field of behavioral economics dates that maximize their own welfare.4 Even be described as emotional, reflexive, back only about 50 years. In Michael if people make mistakes in the process, effortless, impulsive, and short-sighted. Lewis’ 2017 book, The Undoing economists point out that models based If behavioral economists are right, they Project, Israeli-born psychologists on rationality have nonetheless yielded can improve on the predictive ability of Daniel Kahneman and Amos Tversky accurate and useful results.5 Behavioral the models based on standard economic

Social Education 94 assumptions. Therefore, behavioral the experimenter. Again, this seems irra- the print subscription alone; 84 percent economists have focused on areas that tional as the monkeys had been perfectly opted for the combination deal and 16 humans find especially difficult when happy with cucumbers, but now they are percent picked the web subscription. trying to make good decisions. overcome by a sense of unfairness when However, then Ariely repeated the poll their neighbor gets a better reward. Even without offering the unpopular print- Cognitive Biases: Common a monkey will punish itself—throw away only alternative. After all, nobody was Mistakes Humans Make food it likes—to make its point. choosing it, so what difference could it Imagine the following activity—referred make to leave it out? In this second time to as The Ultimatum Game—taking place Anchoring Effect around, 32 percent wanted the print in your classroom.6 In this activity, half A preference for fairness can push people of the students in the class are assigned away from completely rational choices to be “proposers” and the other half are based on self-interest. Another such cog- assigned as “responders.” Each proposer nitive bias is the anchoring effect, some- has to decide how to split $100 with a times referred to as the “framing effect.” randomly assigned responder. The pro- With anchoring effects in play, people’s poser may offer an even split or any other decision-making is influenced heavily by combination. But if the responder rejects the first piece of information offered or the offer, both the proposer and their the most familiar piece of information. responder get nothing. Thaler and Sunstein provide an example This game has been replicated by of Chicago residents who were asked to many researchers using diverse samples guess the size of Milwaukee, Wisconsin.9 of people, and the results tend to be Because their subconscious anchor is the Visual 1 consistent.7 The most common offer is city they know well, Chicago, they will a 50/50 split and both parties get $50. tend to guess too high—guessing about A more aggressive proposer might say one-third the size of Chicago, or about to a responder, “I get $60 and you get 1 million residents. People from Green $40.” About 20 percent of such low Bay, Wisconsin, do the same thing, but offers to the responders (offers of less use what they know, Green Bay, as their than a 50/50 split) are rejected. These anchor. They are likely to guess about rejections are surprising to rational three times bigger than their hometown choice economists. Why? The answer or about 300,000 inhabitants. It turns is that rejecting $40, or any offer above out the correct answer is between the zero, seems irrational. The responders two; about 580,000 people reside in Visual 2 are essentially choosing to punish them- Milwaukee. selves by not taking free money. Why Well-known behavioral economist subscription, while 68 percent preferred would they do this? The conclusion of Dan Ariely shows an anchoring effect to go web-only. It appears that the pres- most researchers is that people seem to in pricing using The Economist maga- ence of the clearly inferior option altered care about fairness, even when it may not zine in his book Predictably Irrational.10 the decision process by making the com- be strictly rational. Examine Visual 1, above right. You can bined web and print subscription seem Interestingly, this same sense of fair- get access to all of the web content for like a better deal. Print only became ness seems to also exist among animals. $59, a subscription to the print edition an anchor as the most familiar piece of Experiments have been done with capu- for $125, or a combined print and web pricing available and people concluded chin monkeys, as well as with other ani- subscription which is also priced at $125. they might as well buy the combination mals, in which they are asked to do a Intuitively, the offer of the print-alone of print and web access because it was simple task in exchange for a piece of option seems absurd. Nobody would such a great deal. Even so, this anchoring food.8 Monkeys that are in cages next to rationally choose to forgo web access effect drove consumers toward choosing each other will do the task over and over when it costs nothing extra, so why even the much more expensive option. again for the reward of a piece of cucum- list it? Why not just say that the print ber. However, if one of the monkeys subscription also includes access to the Loss Aversion gets a grape (which monkeys prefer to web archives? In the book and movie Moneyball, cucumbers) for the task, the animal that Visual 2 helps to demonstrate the Oakland A’s General Manager Billy continues to get a cucumber will revolt answer. Predictably, when all three Beane stated, “I hate losing more than and actually throw the cucumber back at options were available, nobody chose I even wanna win.”11 While he may not

March / April 2019 95 can be a difficult problem for humans the potential loss is emphasized as to overcome; however, recognizing how it often is in retail advertising that Loss aversion is it can affect decision-making may help focuses on trigger words like “last people avoid situations where it can chance” or “Don’t miss out! Act the notion that be a detriment. Here are some classic now!” examples of loss aversion: losses have a bigger • Firms offering free trial periods. • Not selling a stock that is below the Once a consumer has the product, psychological impact price paid simply to avoid taking they become much less willing to a loss or not being able to weather give up something they are used to than gains do. losses in the stock market because having. the loss hurts more than gains.12 • When airlines increased the amount have known it, this quip illustrates the • The unwillingness to sell a home of money offered to passengers in concept of loss aversion. Loss aversion below the price that was paid for it. order to encourage more of them is the notion that losses have a bigger to voluntarily give up their seats on psychological impact than gains do. That • Making a decision based on the mis- flights, consumers instead chose to is, losing $5 feels worse than the good taken logic (or fear) that you might retain their seats at an even greater feeling from gaining $5. Loss aversion miss out on it, particularly when rate than before since they wanted

10 Popular Press Books for Your Class

Nudge: Improving Decisions about Health, Wealth, and Happiness, by that highlights how our eyes can deceive us since our brain often Richard H. Thaler and Cass R. Sunstein, is essential for understand- overrides our reality. In particular, understanding this shortcoming ing behavioral economics, applying it to influencing policy, and is important to acknowledge our hidden biases. the philosophical debate about how behavioral economics is used. The Person and the Situation: Perspectives of Social Psychology, by The Undoing Project: A Friendship that Changed Our Minds, by Lee Ross and Richard Nisbett, is an introduction into how the Michael Lewis, chronicles the collaboration between Daniel environment around us influences our decisions, even if we think Kahneman and Amos Tversky and their original research which we are not taking it into account. changed our thoughts about how decision-making happens. Misbehaving: The Making of Behavioral Economics, by Richard H. Thinking, Fast and Slow, by Daniel Kahneman, dives deeper into Thaler, is the personal story of Thaler’s career in developing behav- his research in how the brain functions in two different systems, ioral economics, highlighting his research and anecdotal stories each with quirks and flaws, with insight into how choices are made that challenged traditional economic thinking. and which system we should rely on. The Paradox of Choice: Why More is Less, by Barry Schwartz, Predictably Irrational: The Hidden Forces that Shape Our Decisions, by describes in depth the idea of consumers’ “Fear of Missing Out” Dan Ariely, explains how our subconscious behavior undermines (FOMO) and how too many choices often result in greater depres- our best interest and that we are at the mercy of these hidden sion and unhappiness due to the perceived losses of the abundant mechanisms if we do not become aware of them. foregone choices. While freedom of choice is important, in this case it comes with a cost and a given decision-maker might be Why Smart People Make Big Money Mistakes and How to Correct marginally happier with a limited range of options. Them: Lessons from the Life-Changing Science of Behavioral Economics, by Gary Belsky and Thomas Gilovich, considers how The Art of Choosing, by Sheena Iyengar, is a psychologist’s per- decision-making and behavioral psychology play a role in why spective of the impact of choice on our lives and highlights an people make foolish decisions with their personal finances. interdisciplinary approach that combines the impact of biology, sociology, economics, and political science on the day-to-day The Invisible Gorilla: How Our Intuitions Deceive Us, by Christopher choices we make. Chabris and Daniel Simons, focuses on research in social science

Social Education 96 to minimize their greater perceived losses.13

• When energy bills include usage comparisons for a neighborhood, a heavy-use customer will decrease consumption slightly. However, if this comparison also includes a frowny-face, highlighting “los- ing” vs. neighbors, energy use will decrease by an even greater degree in order to avoid the loss.14

Status Quo (or Default) Bias People tend to prefer the status quo, even when more attractive options are presented to them. Why do companies do free, limited time offers for things like magazine or cable TV channels? An example of the anchoring effect is that when New York City taxi cabs changed from allowing Probably because they understand the the rider to choose a tip to offering options like 15 percent, 20 percent and 25 percent, their tips status quo bias and that most people, rose, on average, by 8.7 percent. (August 1, 2018, AP Photo/Mary Altaffer) once they have something, won’t extend the energy to cancel it (even if they are reversed, and people were automatically ing options open and freedom to choose. not using it) due to inertia. If a state opted in but had to opt out if they did not Beyond government policies, the chooses to opt people into a program want to participate, more would join and anchoring effect is prevalent in our that allows their organs to be used in case take advantage of the employee benefit. daily lives. It explains why charities of a tragic accident, then most of those It turns out that the behavioral econo- tend to give you some suggested dollar states’ residents will be in the program. mists were right. Before automatic enroll- options for giving—they hope that the If a state requires that you opt yourself ment about 37 percent of employees lowest option anchors your mind that in, much lower percentages of residents participated in these programs and after you certainly shouldn’t give less than will be in the program. automatic enrollment, almost 86 percent this. In addition, when New York City did. This experiment led to changes in taxi cabs changed from simply allow- Nudges: Using Behavioral law and regulation that now allow firms ing the rider to choose a tip to instead Economics in the Real World to opt their employees into their retire- offering options like 15 percent, 20 per- Behavioral economics has the potential ment plans (with an opt-out available). cent and 25 percent, their tips rose, on to influence public policy and improve Automatic opt-in is an example of a average, by 8.7 percent. Again, people’s human decision-making. The government nudge—a small change that pushes people minds were anchored to the idea that of the United Kingdom took this work in a direction that will ideally make them the lowest option is the bottom and that so seriously that it created a behavioral better off. they needed to choose this or something insights team nicknamed “The Nudge Is there a downside to nudges? Some higher, whereas their prior anchor may Unit” after Thaler’s well-known book.15 are concerned that this type of reliance have been not to tip at all. The most famous example of the use on behavioral economics to manipulate If you pay close attention to market- of behavioral economics to improve seemingly small decisions leads to gov- ing and advertising, you are likely to be decision-making is in the area of retire- ernment intrusions into private decision- confronted with the idea of loss aversion. ment contributions. Behavioral econo- making. A key aspect of a true “nudge” Rather than highlighting the features of a mists were interested in why so many is that it leaves courses of action open. new fast-cooking oven, the manufacturer Americans typically chose not to sign Someone who truly does not want to opt might focus on the loss of time if you up for their 401(k) plan—even when into a retirement plan still has that choice don’t buy it. Banks might focus on the it included a “free” employer match of under automatic opt-in. When a seem- loss in fees if you don’t switch to their some kind. They surmised that the reason ingly innocent choice becomes manda- new no-fee checking account. You might was a form of status quo bias. People had tory, the nudge turns into a shove. Even lose your mobility if you don’t buy this to actually fill out some forms and opt into so, well-placed nudges may improve wheelchair or walker, rather than gaining the program. If instead the process was public policy outcomes while still leav- new independence.

March / April 2019 97 recent research in education policy People tend to focused on using simplified, low- Today is the day cost mailers to inform low-income, prefer the status high achieving students about their learning turns into options for college. This implemen- quo, even when tation of nudging is being used to leading. help expand college opportunities more attractive to those who might benefit the most from investing in their human capi- options are tal.17 Additionally, automation of text presented to them. messaging for important reminders relies primarily on the use of nudges. Reminders have been shown to Richard Thaler’s research is full of increase persistence in overcoming interesting “nudges” like these. The the status quo for missing deadlines— most fun example might be the actions we see this use daily in education, of the Amsterdam airport. When healthcare, retail, and even by politi- the facility tired of excessive spill- cians to encourage desired outcomes. age around the urinals in their men’s On a lighter note, long-time fans bathrooms, they chose to make a small of The Simpsons will find an inter- change. They inserted a very real esting and humorous analysis on looking image of a fly in each urinal the spectrum of irrational behav- and spillage declined dramatically. iors exhibited by all of the Simpson Apparently a little nudge—something family members, particularly Homer to aim at—made a huge difference.16 Simpson who, like many of us, is “I highly recommend this online consistently bad at making good master’s in history program. It gave Conclusion choices.18 Sports fans will discover me the confidence in my profession These examples highlight the wide even more real-life examples of to become a better teacher for my range of insight that behavioral persistent decision-making bias and students. Because of this program, economics offers into everyday flawed reasoning layered within the I was able to apply for my dream job. human behavior. Many more appli- book and film Moneyball and see cations are possible. For example, how acknowledging and address- I can now teach at the college level, which is what I’ve always wanted to do. This program has made me who I am today.” Lessons for the Classroom

Laura Enomoto Behavioral Economics Lesson Four —Why Are We So Impatient? highlights the History, MA one inherent flaw in assuming that people are perfectly rational decision- University of Nebraska at Kearney makers by showing what happens when we compare costs vs. benefits that occur in the future. This classroom demonstration illustrates why we are impatient and choose what benefits us immediately, especially when costs are realized in the future. www.econedlink.org/resources/behavioral- economics-lesson-four-why-are-we-so-impatient/ online.nebraska.edu Behavioral Economics Lesson Five—Other Things Matter demonstrates how you can play the Ultimatum Game with your students to prompt a dis- cussion of decision-making for Humans vs. Econs and how other factors influence economic behavior (www.econedlink.org/resources/behavioral- economics-lesson-five-other-things-matter/). Download all of the Behavioral Economics lessons from the Council for Economic Education www.econedlink.org/resources/how-to-use-the-behavioral-economics- lessons/.

Social Education 98 ing these flaws, with the help of an 10. Dan Ariely, Predictably Irrational: The Hidden economist, allowed them to build Forces That Shape Our Decisions (New York: Harper Perennial, 2009). 19 Online History, MA a competitive team. Most recently, 11. Michael Lewis, Moneyball: The Art of Winning behavioral economics was featured an Unfair Game (New York: W.W. Norton and prominently in the hit 2018 movie, Company, 2004). University of Nebraska 12. Gary Belsky and Thomas Gilovich, Why Smart Crazy Rich Asians, which focused on People Make Big Money Mistakes and How to at Kearney two characters’ strategies navigating Correct Them: Lessons from the Life-Changing Science of Behavioral Economics (New York: family dynamics and focused on the Simon and Schuster, 2010). powerful influence of loss aversion.20 13. Hideki Fukui and Koki Nagata, “Do Bumped As the fields of psychology and Passengers Exhibit Loss Aversion? Evidence from the U.S. Airline Industry” presented at the ITEA economics become more deeply Annual Conference and School on Transportation Application deadline intertwined and continue to adapt Economics (Barcelona, Spain, 2017). for fall semester is and learn from each other, even 14. Center for Environmental Behavior, “Nudging Environmental Behavior” (Davis, Calif.: UC June 15. If you’d like more relevant and active uses of Davis, 2013), http://environmentalpolicy.ucdavis. behavioral economics are in our edu/node/291. to start this summer, 15. The Behavioral Insights Team in Partnership with near future. Students, teachers, par- the United Kingdom Government’s Cabinet contact us about ents and policymakers can all ben- Office, “Who We Are” (2014), www. efit from the insights of behavioral behaviouralinsights.co.uk/. options for taking a 16. Big Think, “Improving Men’s Urinal Aim: An economics and leverage its power. Example from Nudge by Richard Thaler” (2012), course or two. Integrating these brief lessons and www.youtube.com/watch?v=OaLGg1wYztk. 17. Caroline M. Hoxby and Sarah Turner, “The facilitating an open and active dis- Hamilton Project–Informing Students about their cussion will help spark curiosity College Options: A Proposal for Broadening the into this emerging area of study and Expanding College Opportunities Project,” Brookings Institute Discussion Paper 2013–03 improve the relevance of economics (June 2013): 1-32. for your students. 18. Jodi Beggs, “Homer Economicus or Homer Sapiens? Behavioral Economics in The Simpsons,” in Homer Economicus: The Simpsons and Economics, ed. Joshua Hall (Stanford, Calif.: • Thesis and Non-Thesis Notes Stanford University Press, 2014), 161–176. Options 1. Adam Smith, 1723–1790. The Wealth of Nations; 19. G. Dirk Mateer, Brian O’Roark, and Kim Holder, Edited, with an Introduction and Notes by Edwin “The 10 Greatest Films for Teaching Economics,” Cannan (New York: Modern Library, 1994). The American Economist (2016): 1–13. • Low Student to 2. Michael Lewis, The Undoing Project: A 20. Cornell University, “Game Theory in Crazy Rich Friendship that Changed the World (New York: Asians” (Ithaca, N.Y.: Cornell University, 2018), Faculty Ratio W.W. Norton & Company, 2017). http://blogs.cornell.edu/info2040/2018/09/14/ 3. Richard H. Thaler and Cass Sunstein, Nudge: game-theory-in-crazy-rich-asians/comment- • Extensive Online Improving Decisions about Health, Wealth, and page-1/. Happiness (New Haven: Yale University Press, Course Offerings 2008). 4. Adam Smith’s less famous book The Theory of in Areas Such as Moral Sentiments (London: Pantianos Classics, 1759) makes it clear that he believed much of American, European, human behavior was under the influence of the “passions” or emotions, such as fear and anger, but World, Public and that these passions were moderated by an internal “voice of reason.” Digital History 5. Milton Friedman, Essays in Positive Economics (Chicago: University of Chicago Press, 1953). 6. A version of this game is contained in a lesson referenced at the end of this article from the M. Scott Niederjohn is Dean of the Council on Economic Education in the “Lessons School of Business and Entrepreneurship, in the Classroom” section. Charlotte and Walter Kohler Professor of 7. Werner Güth, Rolf Schmittberger, and Bernd Economics, and Director of the Center for online.nebraska.edu Schwarze, “An Experimental Analysis of Economic Education at Lakeland University Ultimatum Bargaining,” Journal of Economic in Sheboygan, Wisconsin. Kim Holder is Behavior and Organization 3, no 4 (December Director of the Center for Economic Educa- 1982): 367–388. tion and Financial Literacy at the University 8. TED Blog Video, “Two Monkeys Were Paid of West Georgia in Carrollton, Georgia, and Unequally: Excerpt from Frans de Waal’s TED a Lecturer of Economics in UWG’s Richards Talk,” (2013), www.youtube.com/ watch?v=meiU6TxysCg. College of Business. 9. Thaler and Sunstein, Nudge: Improving Decisions about Health, Wealth, and Happiness.

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