EC Richard Thaler: The 2017 Nobel Prize In Economics

The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel for 2017 has been awarded to Richard Thaler "for his contributions to behavioural economics." What is behavioural economics, and why does it merit the prize? The Nobel committee offers some useful resources for addressing these questions, including ashortand readable "popular information" essay "Easy money or a golden pension? Integrating economics and psychology,"  and a longer "advanced information" essay that digs a little deeper into the economics, "Richard H. Thaler: Integrating Economics with Psychology."

The committee writes: "Richard Thaler has contributed to expanding and refining economic analysis by considering three psychological traits that systematically influence economic decisions – limited rationality, perceptions about fairness, and lack of self-control." Here, I'll say a few words about each of these, and about the state of behavioral economics as a whole.

As an example of limited rationality, consider a survey question from one of Thaler's studies. 

"(a) Assume you have been exposed to a disease which if contracted leads to a quick and painless death within a week. The probability you have the disease is 0.001. What is the maximum you would be willing to pay for a cure?
(b) Suppose volunteers would be needed for research on the above disease. All that would be required is that you expose yourself to a 0.001 chance of contracting the disease. What is the minimum you would require to volunteer for this program? (You would not be allowed to purchase the cure.)"

Notice that in both (a) and (b), you are asked to put a monetary value on facing a 0.001 probability of death. However, for people who took this survey in 1980, a common answer to question (a) was $200, while a common answer to question (b) was $10,000. But the scenarios are framed differently, and Thaler often finds himself digging into "framing effects." He refers to this an example of an "endowment effect," which is that that when you already have something, you tend to set a price differently than if you don't have something. If you are selling your own house, you ask for a higher price than you would offer if buying an essentially similar house.

"Mental accounting" is another example of a limited rationality. "One example is how many people divide their household budget into one account for household bills, another for holidays, etc., with rules that prevent using money from one account to pay for something in another." As one example, may people have both a savings account, where they receive a low rate of interest, and a credit card overdraft, on which they are paying a high rate of interest. However, they don't use the savings account to pay off the credit card, because a "savings account" is separate in their minds from their consumption spending. And of course, this separation may be good thing, if it helps people discipline themselves to pay off their credit card debt without eliminating their saving. 

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