Back in ’80s, American economist Richard H. Thaler introduced ideas that made an exceptional input to the development of behavioral economics, branch of psychology that studies the economic decision-making processes of individuals.
Curse of the Winner
Thaler is confident that auction winners often lose their money as they are overpaying for lots they buy. The winner’s curse manifests itself in two forms: when a person pays higher price for an item than its fair value or when purchased item does not live up to his expectations in the end. Thaler believes that this phenomenon proves the irrational behavior of bidders.
The economist explains the winner’s curse by the tendency of people to make mistakes when they try to assess the value of the lot to offer the right price. In addition, people compete with each other due to the large number of bidders, thus contributing to price raising.
Another Richard Thaler’s idea is that people overestimates the value of items they own. Dubbed “ownership effect,” this phenomenon explained by the fact that a person is strongly attached to his things.
The reason for this may be related to the fear of loss, when people tend to overestimate the pain of losing something and underestimate the pleasure of acquiring it.
Forethought is a very useful quality
Everyone knows that it is necessary to save money for old age, but relatively not too many people really do it. This is because it is difficult to combine long-term saving strategy with everyday needs. For instance, lots of people spend money on cigarettes, although they realize that they could accumulate a decent amount by abandoning the bad habit.
Thaler’s model “planner-doer” explains this phenomenon. In this model, an individual is assumed to be both a narrow-minded doer, who evaluates options just for their current value, and a farsighted planner, who is concerned with lifetime utility.
According to Richard Thaler’s “Push theory,” external factors, the so-called push, affect decision-making. That is, external influences are able to push a person to make the right choice. This is actively used by marketers, pushing people to make purchases.
People Overreact to Bad News
Another one Thaler’s concept is that people underestimate good news and overreact bad ones. According to Thaler, it is better for many investors not to receive monthly financial statements. For example, if in recent years investments have brought a small profit, then the investor, reacting violently to this news and panicking, only worsens the situation. This adversely affects exchange rates.