Richard Thaler's "Misbehaving" Volume 1 // Part 1

This Chapter of the book was split into 6 sections; Supposedly Irrelevant Factors, The Endowment Effect, The List, Value Theory, California Dreamin', and The Gauntlet. 

The author, Richard H. Thaler, uses this first chapter to detail many of the basic and foundational principles upon which the rest of the book is built. Throughout these chapters and the rest of the book, Thaler uses a certain economic idea; the Econ. In his eyes, the Econ is the person who acts exactly as they ought to in the sense of economic optimization. The type of person who never thinks of sunk costs, uses emotions instead of facts in a purchase, or sees interactions as simply opportunity costs. Thaler explains that Econs are obviously not indicative of a true human being thanks to this fickle thing called free will. Rather, his use of Econs is meant to show the differences between how humans actually act vs. how economic theory dictates they should. This simple difference and its explanation, which manifests itself with infinitely complex uses, is what makes up the entirety of the book. 

The first section grabbed me almost instantly due to its rather surprising nature. Its name is notably vague and leaves much to be wondered, but its true nature is actually quite easy to understand. Within it, Thaler simply details why real people differ from Econs in their respective economic behavior. These so-called "Supposedly Irrelevant Factors" are expressed to be the actual entire reason why people act so irresponsibly in the eyes of Economic Theory. Thaler details two distinct and identifiable reasons; the complexity of optimization, and innate bias. The first is rather easy to explain, economic optimization is quite difficult for most people. Without a formal education in economic theory, many people wouldn't even know they are living un-optimized lives. In addition, even if they did know, it can make such a small difference in day-to-day lives that many opportunities pass by. For example, if you buy gas for 3.24$ at gas station A instead of driving 30 minutes to gas station B to buy at 3.23$, you are living without optimizing. But no sane person is really going to drive an hour just to save 10-20 cents total on gas. Furthermore, bias exists within humans. We are not emotionless individuals, nor do we act 100% rationally 24/7. Everyone has made a poor choice while mad, sad, intoxicated, or otherwise cognitively clouded. It is in no way a bad thing, nor is it rare whatsoever. However, it does cause us to lack optimization within our lives. Even something completely normal like buying flowers for a partner would be seen as a non-Econ activity based on the fact that it doesn’t produce tangible value. However, I think everyone can understand that situation to be rather silly and obvious.

The second and third sections were quite short and simply detailed the principle for which the prior is named, the endowment effect. The “endowment” that Thaler is referencing is simply the things that you own vs. don’t. These items can be as obvious as a car, house, or phone, or as complex as memories, thoughts, and emotions. The whole idea is that individuals will almost always value what they have already more than anything that they would receive. In other words, people like to do nothing and hold on to things they already have, instead of having to give something up in order to receive another item. The third chapter is aptly named because it is simply Thaler listing different events and experiments he has seen where the endowment effect took place.

The fourth section was rather confusing at first but once I sat on it for a while, I began to understand what Thaler was getting at. The term “value theory” is actually completely devoid of meaning and even the inventor of it later changed it to “prospect theory” so it would be less misleading. Essentially what this theory does is ascertain that there are multiple reasons why someone may make a decision the way they do. This is directly opposed to basic economic theory, which dictates that Econs make decisions because they optimize, not because of anything else. Prospect Theory instead states that an Econ could potentially make a decision that incorporates both optimization and an additional factor. It is quite confusing an idea even for me and I read the whole damn chapter.

The fifth section was an odd one relative to its five sibling chapters. It detailed a time early in  Thaler’s career when he spent time in California accompanying two early adopters of behavior economics (the proper term for the Econ idea I mentioned earlier). While the majority of the chapter was spent describing the oddities of these two economists and how they worked, there was one idea that I really got caught by. Thaler explained a situation that exhibits the odd nature of behavioral economics perfectly. It goes something like this. You, a gambler, experience two betting scenarios, Bet A and Bet B. Bet A says you have a guaranteed chance to lose 200$ or a 50/50 chance to lose 400$. Bet B says you have a guaranteed chance to win 200$ or a 50/50 chance to win 400$. An Econ would choose the 200$ option in both scenarios because it provides the greatest gain and easiest loss for the lowest risk. However, in a real situation, a person will usually pick the 200$ loss and 400$ win. This odd mismatch is what behavioral economics is all about. Why are some people willing to give up a guarantee just for a chance?

The last section in this section was another interesting one. It got its name from what Thaler describes as “the gauntlet” of questions and ideas every economist must deal with in their professional lives. What he means by this is that there are a few ideas and events that happen in the real world that do not happen in the perfectly optimizing world of Econs. Things like incentives (both positive and negative), learning, and the fact that sometimes it really doesn’t matter can impact how we as humans make decisions. Thaler gives the example of dessert after dinner to show this. If I am at dinner and I spend a not insignificant amount of money on a nice slice of chocolate cake, I am probably going to eat it regardless of how full I may feel. Optimization tells me I should ignore how much I paid and not eat the slice if I already feel full, but most people like to “get their money's worth” in life. The problem here is that no matter which decision you make, whether you eat the slice or not, things are probably going to be fine. One slice of cake wasted won’t bring the world to its knees. One slice of cake eaten on a full stomach also won’t kill you. So, in the end, it really doesn’t matter, but it does for the bigger picture. Thaler ends by describing how he is going to explain this idea further in later sections, so stay tuned for that.