Richard Thaler, one of the fathers of behavioral economics and a professor at the Booth School of Business at the University of Chicago, has won the 2017 Nobel Memorial Prize in Economic Science.
Renowned for his use of data to observe and predict how people behave in the real world, Thaler’s career has been a lifelong war on Homo economicus, that mythical species of purely rational hominids who dwell exclusively in the models of classical economic theory. In studies that borrowed from psychology, sociology, and plain-old curiosity, Thaler demonstrated that mankind was afflicted by emotion and irrationality, which influences their decision making on everything from retirement savings, to health-care policy, to professional sports.
But Thaler didn’t contend that humans were randomly irrational. More importantly, he observed that people are predictably irrational (to borrow a term from the economist Dan Ariely). Some of Thaler’s most interesting work studied the predictably irrational effects of ownership, confidence, and a sense of fairness.
Ownership: According to classic economic theory, a product’s value shouldn’t depend on ownership. In one of his most famous experiments (which he conducted with the Nobel-winning psychologist Daniel Kahneman), Thaler gave mugs to half the students in a classroom and asked the students to assign a value to the mugs. Students who already had a mug considered it twice as valuable those who did not. People place a higher value on what they already own—a so-called “endowment effect.”
Confidence: More information should lead to better decision-making—in theory. But in a study of the NFL draft, Thaler found that professional teams place too much value on early picks, in large part because smart scouts delude themselves into thinking that they can forecast the next superstar. “The more information teams acquire about players, the more overconfident they will feel about their ability to make fine distinctions,” Thaler wrote. This suggests that a downside of “Moneyball” strategies and advanced analytics is that it makes sports teams overconfident about their forecasting abilities.
Fairness: Thaler’s research has shown that people have firm standards of fairness. Since most consumers don’t know what goods are actually worth, they determine value based on what seems fair. Perhaps $5 for an umbrella is fair—but what if the price was raised from $1 during a downpour? That familiar feeling that one is being gouged might discourage sales in ways that have nothing to do with the utility of the umbrella. In recessions, employers tend to fire workers rather than cut their wages, perhaps out of a sense that workers will consider pay cuts to be unfair.