Quasi-Rationality
Imagine that you purchased a ticket to a concert given by
your favorite musical group. On the evening of the concert,
a blizzard makes travel extremely hazardous. Would you go?
Now imagine that you had been given this same ticket. Would
you be more or less likely to travel to the concert in this
case than in the previous case?
Or, suppose that you were given $200 and these two
options: A) a sure gain of $50 or B) a 25% chance of winning
$200 and a 75% chance of winning nothing. Which would you
choose? Now, suppose that you were given $400 and these two
options: C) a sure loss of $150 or D) a 3/4 chance of losing
$200 and a 1/4 chance of losing nothing. Which would you
choose?1
If you are like most people, you would be less likely to
go to the concert if the ticket were given to you. However,
this response is, according to the logic of economics,
irrational. If you are like most people, you will choose A
over B and D over C in the second example. Again, this is an
irrational response. Examples such as these suggest that we
should be cautious in assuming that people are rational
calculating machines. There are cases in which people
deviate from the behavior that the simple calculus of
utility maximization says they should follow, and these
deviations are predictable. Richard Thaler said that this
behavior was "quasi-rational," a clever term that others
sometimes use. More often, the study of these situations,
and more generally the attempt to incorporate insights from
psychology into economics, is called behavioral
economics.
When given the concert example, many people find it
difficult to believe that it should make no difference how
one obtains the ticket.2 The easiest way to see
the logic of economics is to ask what determines the value
of the ticket. Is it the cost of the ticket or is it the
value of the concert? If it is the value of the concert (the
economist's answer), it should be obvious that you should be
equally likely to go in either case. If you want to say it
is the cost, what is the value of a forged ticket that you
bought? Does it have value because you spent money on it,
even if it will not get you admitted to the concert?
If you analyze the second case above, you will see that
situation A and C are identical, as are B and D. In A or C,
one is offered a sure gain of $250; and in B or D, one is
offered a 25% chance of $400 and a 75% chance of $200. Yet
the way of framing the question seems to trick the human
mind into seeing these options in very different ways.
The economists and psychologists studying these anomalies
have suggested that our mental abilities cannot process the
economic information in our lives as the abstract
logic of consumer choice says we should, and in order to
deal with it, we develop mental accounting systems.
Sometimes, these systems are more than mental, as when
families have separate savings accounts for various items.
They will often borrow money rather than dip into one of
these special accounts, though a calculating-machine mind
would never do that.
One feature of most mental accounting systems is that
they start from a fixed point, usually the status quo.
Changes coded as losses seem to have a greater emotional
impact than changes coded as gains. As a result, if a
situation is seen as an actual loss rather than as a gain
not taken, it has a greater impact on people than if it is
seen in the other way. However, economic theory says an
actual loss and a gain not taken are equivalent.3
This asymmetry in dealing with losses and gains is called
"loss aversion."
If we can be fooled by the way situations are framed,
people selling things to us should be smart enough to take
advantage of this computational defect. There are a number
of situations in which this seems to happen.
We are more pleased with many small gains than one big
gain of equal magnitude--we would rather get our Christmas
presents in lots of boxes rather than one big one. There are
innumerable sales pitches that promise something free if and
only if we buy a product. If we think about this, we realize
that nothing is free--we are paying for the complete
package. Yet, the popularity of this type of sales pitch
suggests that it works.
Alternatively, we are less affected by one big loss than
a number of small ones of equal value. One of the appeals of
credit cards is that they give us the bad news as one
number. Also, sellers know that when we make a large
purchase, they have an opportunity to sell us even more. If
we are paying $100,000 for a house, an extra $1000 does not
seem to be much to add on some conveniences. However, if we
see the extra $1000 as a completely separate transaction, we
may react in a very different way.
Although the free trial with money-back guarantee is a
way to signal quality, it also takes advantage of our mental
accounting. Once we have an item at home and in use, it
becomes part of the status quo. Giving it up is coded as an
actual loss rather than a gain not taken and affects us
more.
If you are still dubious about people relying on mental
accounting rules, ask yourself why so many prices are in
nines: $9.95, $19.95, $999.99, etc. Why not simply round
them up to an even number? The author has been immersed in
economics for almost 30 years and finds it amusing that he
has mental accounting techniques that violate the logic of
economic choice and that they are so deeply ingrained he
cannot get rid of them. If you start examining how you view
the world, you will probably find that you too often make
decisions in ways that violate the logic of choice.
Having seen that one can harbor reservations about the
traditional theory of choice, we next return to that theory
to see why economists prefer cash to
in-kind transfers.
1 This example is from Slovic and
Lichtenstein, "Preference Reversals," American Economic
Review, Sept. 1983, p. 601. Much of the rest of the
material is based on Richard H. Thaler's Quasi Rational
Economics (New York: Russell Sage Foundation,
1991).
2"The lure of the sunk cost is
so strong in this problem that, when it is presented to
subjects untrained in economics, substantial explanations
must be given to convince subjects that the economic
analysis is sensible." Thaler, p. 148.
3The fact that people consider
losses as different from foregone gains seems to have been
understood by Aristotle. "It is easier not to take than to
give because we are more inclined to be too stingy with our
own goods than to take another's." See his Nicomachean
Ethics, Book IV.
Copyright
Robert Schenk
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