layout: true background-image: url(figs/tcb-logo.png) background-position: bottom right background-attachment: fixed; background-origin: content-box; background-size: 10% --- class: title-slide .row[ .col-7[ .title[ # Consumer Behavior ] .subtitle[ ## Biases, Cognitive Limitations and Consumer Behavior ] .author[ ### Dennis A.V. Dittrich ] .affiliation[ ] ] .col-5[ ] ] ??? # Two Definitions of Rationality .col-7[ **Present-aim standard**: a person is rational if she is efficient in the pursuit of whatever aims she happens to hold at the moment of action. * No attempt is made, under this standard, to assess whether her aims themselves make any sense. **Self-interest standard**: a person is rational if her motives are congruent with her narrow material interests. ] --- class: practice-slide .row[ .col-8[ David Friedman once told a class that love is the most overrated part of marriage. He suggested that people get married because of the gains of comparative advantage, and stay married only as long as those gains are present. One student became incensed at the idea and told later she even lost sleep over the cold view of human relationships. Is Friedman's suggestion accurate? ] .col-4[ ![](img06/DavidFriedman.jpg) .caption[By Gage Skidmore, CC BY-SA 3.0] ]] --- ## Non-selfish preferences .col-7[ "_Greed is good_." -- Standard Economics? Contract enforcement is of central economic importance * Very often there are enforcement problems because contracts are inherently incomplete * (Many) Labor contracts = fixed wage without explicit performance incentives. * Workers have a large degree of discretion over effort levels `\(\Rightarrow\)` Moral hazard problems and inefficiencies * Voluntary cooperation highly relevant * Firms' managers have to be able to interpret and anticipate the employee's job attitude. * Fair behavior reduces transaction costs in markets by reducing cheating ] --- # Reciprocity .col-7[ Reciprocity as a contract enforcement device * When people behave reciprocally they evaluate the intentions of others and reciprocate kind with kind and unkind with unkind behavior * Rabin, 1993, Incorporating Fairness into Game Theory and Economics * Falk & Fischbacher, 2006, A theory of reciprocity * Cox, Friedman, Gjerstad, 2007, A tractable model of reciprocity and fairness * Psychological Game Theory Beliefs & Payoffs are not independent ] --- ## An Altruistic Person .row[.col-6[ The Indifference Map ![](img06/Chapter070.png) ] .col-6[ The Optimal Income Transfer ![](img06/Chapter071.png) ]] --- .row[.col-6[ ![](img06/Chapter072.png) ] .col-6[ ### A Utility-Maximizing Altruist ]] --- class: practice-slide .row[ .col-6[ _Thought Experiment:_ Imagine I give you 10 Euro and tell you have to make an offer to an anonymous second student in another class on how to divide the 10 Euro. You have to state how many Euro you want to give to the unknown student. If they agree, the money is shared in the proposed way. If they reject you both get nothing. How much do you offer? ] .col-6[ _Thought Experiment:_ Imagine I give you 10 Euro and tell you that you can keep it all, or share it with an anonymous second student in another class. Do you keep everything, or do you share some of the money with the unknown student? If you share, how much do you give? ] ] --- ## The Ultimatum Game .row[.col-8[ <img src="img06/Chapter074.png" width="716" /> ] .col-4[ The Trade-off between Absolute Wealth and Relative Gain: **Inequity Aversion** ]] --- ## The Gain from Rejecting a One-Sided Offer <img src="img06/Chapter075.png" width="95%" /> --- class: practice-slide .col-8[ Imagine that the U.S. is preparing for the outbreak of an unusual Asian disease, which is expected to kill 600 people. Two alternative programs to combat the disease have been proposed. Assume that the exact scientific estimates of the consequences of the programs are as follows: .large[1. If program A is adopted, 200 people will be saved. 2. If program B is adopted, there is a one-third probability that 600 people will be saved and a two-thirds probability that no people will be saved. ] Which of the two programs would you favor? ] --- class: practice-slide .col-8[ Imagine that the U.S. is preparing for the outbreak of an unusual Asian disease, which is expected to kill 600 people. Two alternative programs to combat the disease have been proposed. Assume that the exact scientific estimates of the consequences of the programs are as follows: .large[1. If program C is adopted, 400 people will die. 2. If program D is adopted, there is a one-third probability that nobody will die and a two-thirds probability that 600 people will die. ] Which of the two programs would you favor? ] --- ## Utility of a Pair of Events That Increases Total Wealth .row[.col-8[ <img src="img06/Chapter076.png" width="100%" /> ] .col-4[ **Rational choice**: Any combination of events that increses total wealth will also increase total utility. ] ] --- # The Asymmetric Value Function .row[ .col-7[ **Reference dependent utility** People evaluate alternatives not with the conventional utility function, but instead with a _value function_ that is defined over _changes_ in wealth. People treat gains and losses asymmetrically, giving the latter much heavier weight in their decisions than the former. * Value function is much steeper in losses than in gains. * Does not necessarily imply irrational behavior. People evaluate events first and then add the separate values together. * They typically evaluate each item of a collection of events separately ] .col-5[ **Kahneman, Daniel; Tversky, Amos** (1979). "Prospect Theory: An Analysis of Decision under Risk". Econometrica. 47 (2): 263–291. ![](img06/kahnemantversky.jpg) ] ] --- ## The Kahneman-Tversky Value Function <img src="img06/Chapter077.png" width="75%" /> --- class: practice-slide .col-8[ The policy of one school was to punish students for being late, while the corresponding policy in an otherwise identical school was to reward students for being on time. If effectiveness is measured by behavior on the day following punishment or reward, which policy would seem to be more effective? ] --- # Which circle is the darkest? <img src="img06/contrast.svg" width="100%" /> --- # Are all lines parallel? <img src="img06/bulge2.svg" width="50%" /> --- class: practice-slide .row[ .col-3[ ![](img06/cointoss.jpg) ] .col-7[ Suppose that a fair coin is tossed repeatedly and the outcomes produce (h, h, h, t, h, h, h, t, h, h, h). What will the next coin toss show? ]] --- ## Illusion of Patterns & Patterns of Illusion .row[ .col-3[ ![](img06/cointoss.jpg) ] .col-7[ Suppose that a fair coin is tossed repeatedly and the outcomes produce (h, h, h, t, h, h, h, t, h, h, h). * Both h and t have the same probability of occurrence. * People seek meaningful explanations for the patterns. * Random patterns can fool us! ] ] .row[ .col-7[ **Small sample bias** leads to inaccurate statistical reasoning. **Confirmation Bias** creates a skewed perception of _reality_. ]] --- class: practice-slide .col-8[ **Sophomore jinx** In baseball and other professional sports the rookie of the year typically performs at a much lower level in the next season. **Sports Illustrated jinx** An athlete whose picture appears on the cover of Sports Illustrated one week is destined to do poorly the next. Why this pattern? ] --- .row[ .col-6[ ![](img06/cake1950.png) ] .col-6[ ## The IKEA effect: Labor Leads to Love The initial introduction of instant cake mixes in the 1950s was a failure. * The mixes were too easy, suggesting that the housewives' labor was undervalued. When manufacturers changed the recipe to require the addition of an egg, adoption rose dramatically. **Labor enhances _affection_ for its results**. Consumers are willing to pay a premium for do-it-yourself projects. ]] --- # Sunk Costs .row[ .col-6[ _Thought Experiment:_ Imagine that you have bought a pair of fashionable shoes for $600, only to discover that they are painfully tight. They improve slightly after being broken in, but still cause considerable discomfort. Question: Do you continue wearing these shoes or give them away? Would your response be any different if you had not bought the shoes but instead had received them as a gift? ] .col-6[ _Thought Experiment:_ You have just paid $40 for tickets to a basketball game to be played tonight in an arena 60 miles north of your home. Suddenly it starts snowing heavily and the roads north, while passable, are difficult. Question: Do you still go to the game? Would your answer have been different if, instead of having bought the tickets, you had received them for free? ]] --- # Escalation of Commitment .row[.col-7[ ![](img06/concorde.jpg) **Concorde Fallacy**: With only 20 aircraft built, the development of the Concorde represented a substantial economic loss, in addition to which Air France and British Airways were subsidized by their governments to buy them. Also called the ''sunk cost fallacy.'' ] .col-5[ "In for a penny, in for a pound" ]] --- # Affective Forecasting Errors .row[ .col-7[ _Thought Experiment:_ A man is trying to decide whether to trade in his Toyota Corolla for a new Porsche Boxster. He could meet the payments on the new car by working an additional Saturday each month, which in his case would mean not spending that Saturday with friends. Question: How should he choose between the two cars? What would be the prediction of the Rational Choice Model? ] ] ??? ## Static and Rising Consumption Profiles .row[ .col-7[ _Thought Experiment:_ You are deciding between two different consumption profiles that could be financed from the same stream of lifetime earnings. In each case you and all others in your age cohort will earn a salary of $50,000 each and every year from age 21 until retirement at age 65. ]] .row[ .col-6[ Two possibilities: 1. You and the others spend exactly your salaries of $50,000 each year. 2. You and the others start out by saving $10,000 a year, then gradually diminish your rate of saving until, by middle age, you begin drawing down your savings in ever larger amounts to finance additional consumption. ] .col-6[ ![](img06/Chapter079.png) ]] --- ## Representativeness .row[ .col-7[ ![](img06/Chapter0710.png) Distribution by Type of Librarians and Salespersons ] .col-5[ Suppose that 80 percent of all librarians are shy, but only 20 percent of all salespeople. Suppose further that there are nine salespeople in the population for every librarian. Under these reason- able assumptions, if we know that Steve is shy and that he is either a librarian or a salesman, what is the probability that he is a librarian? ]] --- class: practice-slide .col-9[ Two cab companies operate in a given city, the Blue and the Green (according to the color of cab they run). 85% of the cabs in the city are Blue, and the remaining 15% are Green. A cab was involved in a hit-and-run accident at night. A witness later identified the cab as a Green cab. The court tested the witness’ ability to distinguish between Blue and Green cabs under nighttime visibility conditions. It found that the witness was able to identify each color correctly about 80% of the time, but confused it with the other color about 20% of the time. What do you think are the chances that the errant cab was indeed Green, as the witness claimed? ] --- # The Psychophysics Of Perception .row[.col-7[ You can try this at home: Imagine three buckets of water on a table in front of you. The left bucket contains very hot water. Put your left hand into that bucket. The right bucket contains ice water. Put your right hand into that bucket. Leave both hands in their respective bucket for a minute. Now place both hands into the middle bucket, which contains water at room temperature. You will be hard pressed to believe your eyes, which tell you that both hands are in the same bucket. Nevertheless, your left hand will experience the room temperature as very cold, while your right hand experiences it as very hot. Each hand’s sensation is driven by a comparison and contrast to the temperature that preceded immersion in the middle bucket. ] .col-5[ __Weber-Fechner law__: the property of perception whereby the just noticeable difference in a stimulus tends to be proportioned to the value of the stimulus. ]] --- class: practice-slide .row[ .col-6[ _Thought Experiment:_ You are about to buy a radio. The radio’s price is $25. The sales person tells you another store that is just a 20 minutes drive away sells the radio for just $20. Do you take the drive to buy the radio for the lower price? ] .col-6[ _Thought Experiment:_ You are about to buy a TV. The TV’s price is $500. The sales person tells you another store that is just a 20 minutes drive away sells the TV for just $495. Do you take the drive to buy the TV for the lower price? ] ] --- class: practice-slide .row[ .col-6[ _Thought Experiment:_ You are about to buy a pen. The pen’s price is $5. The sales person tells you another store that is just a 20 minutes drive away sells the pen at a lower price. How low would the price at the other store need to be, so that you were willing to take the drive to save some money on the pen? ] .col-6[ _Thought Experiment:_ You are about to buy a computer. The pen’s price is $3000. The sales person tells you another store that is just a 20 minutes drive away sells the computer at a lower price. How low would the price at the other store need to be, so that you were willing to take the drive to save some money on the computer? ] ] --- class: practice-slide .col-8[ Why do real estate agents often show clients two houses that are nearly identical, even though one is both cheaper and in better condition than the other? ] --- # The Difficulty Of Actually Deciding .row[ .col-7[ For many pairs of alternatives utility functions just don’t seem to assign clear, unambiguous preference rankings. * Difficulty is most pronounced when the alternatives differ along dimensions that are hard to compare. ]] .row[.col-6[ ### Choosing between Two Apartments ![](img06/Chapter0711.png) ] .col-6[ ### Adding an Irrelevant Alternative ![](img06/Chapter0712.png) ]] --- ## Choice Architecture .row[.col-5[ One of the findings of behavioral economics is that **choice architecture** impacts people's decisions * Choice architecture is the context in which decisions are presented * Adopting the behavioral economic framework opens up many ways in which government can usefully intervene in the market * A **nudge** is a deliberate design of the choice architecture that alters people's behavior in predictably positive ways * Firms use nudges to guide their customers to make choices that benefit the firm ] .col-7[ ![](img06/excerpt.png) ]] --- ## Organ donation: effective consent rates in different countries <img src="img06/effective_consent.png" width="90%" /> Science, 2003, Johnson & Goldstein