Podcast Summary
Understanding People's Economic Decisions through Behavioral Economics: Behavioral economics challenges traditional economic assumptions by studying how people really make financial decisions, recognizing their emotional and self-control complexities.
Behavioral economics, as explained by Nobel Prize-winning economist Richard Thaler, is the study of how people actually make economic decisions, as opposed to the assumptions of rationality and emotionless behavior in traditional economics. Thaler, known for his "laziness" and focus on important and fun projects, introduced the concept of mental accounting to Shankar Vidantham ten years ago. Mental accounting refers to the way people categorize and handle money in their minds, leading to irrational financial decisions. Thaler emphasized that people are not the fictional, highly rational "econs" assumed in traditional economics, but rather, they are complex beings with emotions and self-control issues. This shift in perspective has made behavioral economics a controversial yet impactful field in economics.
Mental accounting and its impact on our spending behavior: Mental accounting influences how we perceive and manage money, leading to unexpected behaviors and feelings. Separate checking accounts for individual spending while maintaining a joint account for shared expenses can help mitigate these effects and promote marital harmony.
Our perception and management of money, even if it's all coming from the same source, can be influenced by mental accounting – the tendency to mentally categorize and label different types of spending. This can lead to unexpected behaviors and feelings, such as increased satisfaction when our partner pays for a meal or difficulty spending money in certain situations. For instance, mental accounting might make it harder for us to catch cabs on rainy evenings because we've mentally allocated a certain budget for transportation and seeing the cab fare increase due to the weather might make us hesitant to spend the extra money. To mitigate this, consider having separate checking accounts for individual spending while maintaining a joint account for shared expenses. This approach can lead to marital harmony and a better understanding of each other's financial habits.
Mental accounting impacts financial decisions: People apply different rules to their income sources, leading to irrational spending habits
People often apply different rules or mental accounting when managing their finances, leading to seemingly irrational decisions. In the study discussed, cab drivers in Manhattan set targets for their earnings and went home once they reached them, even if it meant leaving money on the table during high-demand periods. Economists would predict the opposite behavior, but research shows that people's spending habits can be influenced by the source of their income. For instance, a study on prostitutes in Oslo found that they spent welfare money responsibly but spent earnings from sex work on less essential items. This concept, known as mental accounting, can also be seen in the movie "Welcome to Me," where a woman's unexpected lottery winnings significantly impacted her spending habits. Overall, understanding mental accounting can help explain why people make seemingly illogical financial decisions.
The source of money impacts spending habits: People perceive and spend money differently based on its source, with non-monetary rewards often leading to greater happiness and less guilt
The source of money significantly influences how we perceive and spend it. As Alice Plague's $86 million lottery win illustrates, receiving money from certain sources can lead to drastic changes in spending habits. For instance, David Leibson, a colleague of the speaker, shared an anecdote about how a $200 honorarium from the National Institute of Health was perceived and spent differently than a similar amount given as a cash bonus or a vacation. Research shows that people report greater happiness when receiving non-monetary rewards, as they don't carry the guilt or pressure to spend the money. The speaker also shared a personal experience of buying her daughter Mets tickets, highlighting how the last-minute purchase led to a higher ticket price and a lesson in the influence of the source of money.
Understanding Self-Control's Complexities: Self-control is a valuable yet taxing resource that individuals often struggle to exercise, leading to societal issues like obesity and insufficient retirement savings.
Self-control is a valuable yet challenging aspect of human behavior. As demonstrated in the marshmallow test experiments, resisting immediate gratification in favor of a later reward requires effort. Economists have often overlooked this concept, assuming that individuals always do what's best for them, including exercising self-control. However, real-life challenges such as obesity and insufficient retirement savings reveal the importance of understanding self-control as a valuable yet taxing resource. People often struggle with delaying gratification, and this can lead to significant societal issues. In the story shared, a woman was excited about attending a baseball game but ultimately failed to use the $1,000 sent to her for tickets, demonstrating the complexities of self-control.
Understanding the influence of emotional states on decision-making: Emotional states can weaken our resistance to temptations and influence our decision-making. Strategies like appointing an external enforcer can help maintain self-control, but it's challenging to stick to commitments when faced with temptation.
Our ability to resist temptations and make rational decisions can be influenced by our emotional states and the situations we find ourselves in. The study of hot and cold emotional states by researchers like George Lowenstein shows that our resistance to temptations can weaken over time. We may promise ourselves to resist certain temptations, like dessert after a meal, but our future selves may have different desires. To combat this, people have tried various methods such as appointing an external enforcer or "dessert referee" to help maintain self-control. This concept can be seen in the TV show "Curb Your Enthusiasm," where Larry David asks a friend to keep him from having dessert. However, even with the best intentions, it can be challenging to stick to our commitments when faced with temptation. Ultimately, understanding the influence of emotional states and situations on our decision-making can help us be more mindful and intentional in our actions.
The hot-cold empathy gap: Our emotions and rational thinking don't always align, leading to inconsistent decisions based on emotional state.
Our emotions and rational thinking don't always align, creating what psychologists call the hot-cold empathy gap. This was illustrated in a study where a woman's desire for dessert fluctuated based on her emotional state. Behavioral economist Richard Thaler, author of "Misbehaving," has made significant contributions to understanding this gap. Hidden Brain, the podcast that explored this concept, is produced by Karima Gargaleson and Maggie Pennman, with assistance from Max Nestrack, Jennifer Long, Sherry Thomas, Neil T. Vold, Andy Heuther, Brian Jarvo, and Jay Seis. For more Hidden Brain, connect with us on Facebook, Instagram, and Twitter, or sign up for our newsletter by emailing hiddenbrain@npr.org with "subscribe" in the subject line. I'm Shankar Vedantam, and this is NPR.
