Anything that interests me - Behavioural Economics

Anything that interests me - Behavioural Economics

I am back! 

It's been a long four years of education here and I'm about to graduate and leave university. 

On Wednesday, I even went down to sign the contract with my employer about the date I shall start work. 

So for the moment it looks like my formal education is almost over, unless of course I manage to get the Master's scholarship, in which case, my formal education will be over next year in 2011 instead. 

In any case, I decided to let this post be a reflection of what I've learnt in behavioural economics, one very interesting and controversial subfield in Economics.

Let's try a few isolated points that I find interesting. 

People don't integrate their assets, but rather use different mental accounting rules to make decisions on gambles and their money. Isn't that curious?

It's curious because most people would say "duh", but economists think that you shouldn't bother about various mental accounts, since it's the total sum of wealth (the whole thing) that you should be concerned with. 

Also, most people think differently from economists about the topic of inflation. Isn't that curious?

It's curious because economists (especially Lucas, who came up with the Misperceptions Model) believe that people do know the models that economists use. 

However, in real life, people don't think the same way as economists do. In fact, most of the time, in real life people behave rather differently from the way traditional economists think they should behave. The key point, as my Professor used to say, was that the deviation is constant or measurable. In other words, they should deviate from traditional or classical economics in a predictable way.  

Next, people suffer from "money illusion" - they tend to, broadly, see nominal increases as very important when they should be bothering about real increases. Isn't that curious?

It's curious because the same people can work out that inflation reduces what they can actually buy with a given sum of money. 

However, the same people are overjoyed when their income rises less than inflation does. Consider this example:

Inflation 10%

Wage increase 10%

Real increase 0% (because the wage increase just offsets inflation)

Yet it turns out that people would be happier in the above case relative to the next case:

Inflation 2%

Wage increase 3%

Real increase 1% (because the wage increase is more than the inflation)

The list goes on and on. So bear with me for two more examples.

People procrastinate. Isn't that curious?

It's curious because it means that people are not time consistent and they are not maximising their utility... or is it? 

The thing is that the present moment has a saliency that traditional standard economics ignores. 

Self 1 of a person wishes to do his homework at period 2, but when period 2 comes, it now becomes the present. Again, he wishes to postpone doing the homework till period 3, and so on. (Interesting stuff - but simplified to fit inside this academic blog.)

I think the best part about the course that struck me was the part on happiness.

There's a hedonic treadmill, and there's a satisfaction treadmill. Treadmill effects are basically effects that wear off, much like a treadmill that keeps going backwards as you are running forwards. You keep on running, but you don't really get anywhere - precisely because it's a treadmill.

A hedonic treadmill means that people don't seem to get any happier because they adapt to happiness levels. As they get richer, they don't get any happier because now it takes much more leisure or things or enjoyment to make them happier. They adapt and get used to the better lifestyle. That's a hedonic treadmill.

On the other hand, a satisfaction treadmill implies that people don't seem to get any happier because of changing aspirations. That means that as people get richer, their aspirations change. What used to make them happy is not enough now. You can see that the reverse is also true. The satisfaction treadmill also suggests that as people break their limbs or become incredibly poor, their aspiration levels are lowered, and hence they don't need as much to make them happy when they're paralysed or poor. Some kind of aspirational or goal change occurs.

Interesting stuff eh?

An interesting, and related, idea is that happiness is found in the moment, yet happiness can also be memory-based and remembered.

Here is where behavioural economics seems akin to philosophy.

Do we remember - mind the pun - to fully immerse ourselves in the moment and feel happy when we are on holiday, or do we keep on taking pictures to reminisce upon our holiday later?

Are we busy enjoying the moment when we savour food, or are we constantly thinking of how happy we were eating that burger yesterday or how happy we are going to be eating that burger later?

Cool stuff. 

Now I get back to studying for my degree.

Anything that interests me! :)