Misbehaving Book Summary

Standard economic theory assumes that people make rational decisions based only on relevant factors. However, behavioral economics recognizes that in the real world, many supposedly irrelevant factors (SIFs) heavily influence behavior. Examples include:

• Framing effects (e.g. 70/100 feels much worse than 96/137 even if the percentage is the same)
• Anchoring (being influenced by arbitrary reference points)
• Availability bias (judging frequency by how easily examples come to mind) SIFs make behavior deviate from what rational models predict. Identifying SIFs and how they impact decisions is a key aim of behavioral economics.

Section: 1, Chapter: 1

Early in his career, Richard Thaler started collecting examples of anomalies - human behaviors that deviated from the predictions of standard economic models. Some examples from his list:

• Paying more attention to sunk costs than rational models say we should
• Refusing to buy or sell items based on apparently irrelevant factors like recent ownership
• Failing to ignore past costs when making decisions
• Avoiding options to constrain our future behavior

At the time, these anomalies were seen as quirks or mistakes, not fundamentally important. But Thaler saw them as clues that the rational models were flawed and needed to be revised to incorporate human psychology.

Section: 1, Chapter: 3

In the late 1970s, Richard Thaler was a young professor trying to apply psychology to economics, but with a hard time getting others to take his ideas seriously. A few key moments:

• On a drive to Stanford, he pondered how to convince skeptical economists that psychological factors really do affect economic decisions
• He discovered the work of Kahneman and Tversky on heuristics, biases and prospect theory, which provided an academic foundation for his ideas
• At Stanford, he met Baruch Fischhoff, Paul Slovic and others studying human judgment, further expanding his knowledge of relevant psychology

However, the economic establishment still viewed behavioral approaches as quirky at best and misguided at worst.

Section: 1, Chapter: 5

One of the key early findings in behavioral economics was the endowment effect - our tendency to value things we own more highly than identical things we don't own. However, Thaler and colleagues ran into several challenges in trying to demonstrate the effect:

• Experimental subjects had to be making real choices with real money at stake, not just hypothetical survey responses, or else economists would dismiss the results
• The experiments had to rule out alternative explanations like transaction costs or implied information value
• Results had to be replicated across different item types and with high levels of statistical significance

In the end, carefully designed experiments involving things like trading mugs and pens provided convincing evidence. But the process illustrates the high burden of proof required to shift established economic wisdom, even in the face of compelling anomalies.

Section: 1, Chapter: 6

As Thaler and colleagues tried to publish early behavioral economics research, they encountered a predictable set of objections from economists, which Thaler dubbed the "Gauntlet":

Overcoming these objections required careful experimental designs and an accumulation of empirical evidence across many studies. But the gauntlet also revealed the reluctance of many economists to incorporate psychological realism into their models, even in the face of contrary evidence.

Section: 1, Chapter: 6

The sunk cost fallacy is our tendency to continue an endeavor once we've invested time, effort or money into it, even when continuing is no longer rational. An example from Thaler's personal life illustrates how mental accounting can exacerbate the effect.

Actively spending money makes the sunk cost highly vivid and painful if the purchase isn't then utilized. We feel the need to "get our money's worth." But this means we often throw good money (or time or effort) after bad, continuing down an unprofitable path.

Section: 1, Chapter: 8

People often use mental budgets or "buckets" to constrain their spending - e.g., $200/month on dining out. But this heuristic can lead to irrational behavior.

In one study, subjects were told they were going to a play. Half were told they had recently spent $50 going to a basketball game (same bucket), while half were told they got a $50 parking ticket (different bucket). Subjects were then asked if they would still buy a ticket to the play.

Those who had gone to the game were less likely to buy play tickets, presumably because they felt they had already spent their entertainment budget for the month. But this makes no sense - the historical spending is a sunk cost and should be irrelevant to the play decision. Yet because it was categorized in the same mental bucket, it still affected their choice.

Section: 2, Chapter: 9