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Behavioral Economics and Richard Thaler

Every year, the great minds of our planet gather in Sweden and decide who made the greatest contribution to the development of the main spheres of science and life. In December 2017, the economist with a symbolic surname Richard Thaler received the Nobel Prize in Economics. The prize was awarded to him for his contribution to the development of behavioral economics. His research is not boring and incomprehensible scientific phrases, but laws that are quite applicable to everyday life, which should be used right now to deliberately and rationally part with your money.

The fact that they awarded the Nobel Prize for their contribution to behavioral economics proves that this branch of the economy is important and relevant. Behavioral economics is at the crossroads of two voluminous sciences: economics and psychology. He explains why we spend money the way we spend. Why there is always a lack of funds, we cannot save money on vacation with every salary.

5 facts about Richard Thaler

  1. The American economist in one of his works calculated the cost of living of an American – $ 7 million.
  2. The prominent Israeli-American psychologist Daniel Kahneman (Nobel laureate, one of the founders of behavioral economics) said about Thaler: “Well, the best quality of Thaler, which really distinguishes him from others, is his laziness.”
  3. He is the author of the “push theory” – a political, psychological and economic concept, according to which any choice can be “carefully imposed”. You can read about this in the bestselling book Nudge (Push).
  4. He was an adviser to Barack Obama and the British government.
  5. He starred in the 2008 film Crisis Downgrade, which was nominated for an Academy Award. The scientist played himself there. He explained how human error contributed to a crisis. According to Thaler, he is disappointed with his film career and does not intend to continue.

Why did Thaler get the Nobel Prize?

Richard Thaler explained how a person or group intelligence decides how to spend money. Thaler “included psychologically realistic assumptions in the analysis of economic decision-making,” the Swedish Academy of Sciences said in a statement from the Nobel Committee, he “gave us a new understanding of how human psychology affects decision-making.”

Thaler himself said: “The most important lesson [of my research] is that economic agents – people and economic models should take this into account.” Thaler deduced the natural consequences of human traits that affect not only the personal distribution of funds but also the global economy. The main characteristics that determine economic behavior are limited rationality, social preferences, and a lack of self-control. Let’s analyze all this in more detail.

Limited rationality: Richard Thaler developed a theory that takes into account the simplifications that people apply when making financial decisions. According to his theory, we use in our minds separate accounts for finances designed for different purposes: small expenses, leisure, entertainment, credit and / or received with varying degrees of effort (salary, random wins, etc.). Thus, we focus on the impact of each individual decision, rather than their overall effect. That is, we hang labels on spending and the amount of money and, based on this, justify our decision to spend or not, how much and why.

For example, money that is won in a bet is much easier to spend than earned at the cost of much effort or a long time. And we can give $ 2 each day for coffee before work because this is a small amount and a pleasant waste, but we can’t save $ 100 for the upcoming vacation.

The scientist also showed how “loss aversion” can explain why people value the thing they own higher, calling it an “ownership effect”. Remember yourself, when during the cleaning you can’t throw out the annoying and unnecessary stuff, because “it’s mine, I bought it myself”.

Behavioral Economics and your financial life

Make a note of your expenses and at the end of the month add up the amounts that you cannot spend in the future. It motivates abandoning bad habits (for example, instead of buying cigarettes, you can save up on a new phone). You will soon realize that small expenses eventually result in a pretty penny. You can refuse unnecessary and learn to spend money rationally.

Social preferences: Thaler revealed that the value system of the individual and society as a whole has an impact on people’s decisions. For example, people believe that justice is an unconditional value. He showed how a commitment to justice can hinder price increases during periods of high demand due to force majeure circumstances for customers, such as natural disasters. But at the same time, it allows firms to raise prices with rising costs.

That is, a person or organization that makes money on someone else’s grief, misfortune, problems, will be deemed immoral, therefore, the image of such a business will fall, and customers will turn away. Such an algorithm explains why a person is ready to donate the latter to charity, and why large corporations are not trusted. For example, there are frequent examples in business when tobacco companies gave money for social advertising about the dangers of smoking, for medical research and the development of drugs for lung cancer. The same theory explains why the same person would deem it fair to buy the same bottle of water for different prices in an expensive restaurant and in a kiosk at a bus stop.

At the same time, values ​​vary at different times, in different countries and even in different sectors of society. Everyone has their own morality. Therefore, Thaler and his colleagues developed a dictatorial game – an experimental tool that has been used in numerous studies to measure adherence to justice for different groups of people around the world. For a businessman, it will be fair to get good money for a job well done, and for a lazy person, the distribution of earnings, regardless of the amount made.

How to use Theories of Behavioral Economics

Analyze your expenses: Ask yourself “why?” And “why?” Why did I commit this waste and why exactly this? Is it fair that a larger sum is spent on morning coffee than on education or achieving one’s own goals? Conduct an experiment: try to spend the money as equitably as possible a month. We assure you that at the end of the month there will be more money than usual if you are critical of yourself.

The lack of self-control: Remember how you recently summed up the results of the year, compiled lists of goals for the next year and made promises to fulfill everything in the New Year? Thaler found out why it is so difficult to control decisions made in the New Year. He derived a formula that analyzes the problems of self-control. When a person makes a promise for a year on New Year’s Eve, it seems to be something very distant that you can always be in time. After all, there’s a whole year of time! On the other hand, urgent decisions are always nervously and hard given to a person. There is always a risk and fear of miscalculation.

At the same time, we easily change and forgive ourselves small momentary concessions, which subsequently greatly affect the quality and standard of living. During a personal fight against smoking, a smoker will never honestly say how many “last” cigarettes he had.

How to cope with the lack of self-control

In his practical work, Richard Thaler demonstrated how pushing can help people better cope with the lack of self-control when accumulating pension funds, as well as in other similar situations. The push is to create conditions conducive to increasing the likelihood of achieving effective social goals. In particular, you can use the “default”, which allows you to use the most preferred option, “push” it if there are several alternatives, without an explicit indication. However, other options can be used, but the person no longer wants to prefer them.

Pushing is one of the types of “soft power”, providing an increase in the probability of achieving social goals while preserving the freedom of choice and the possibility of using other options. The pushing politician is called “paternalistic liberalism.”

Based on his research, Thaler proposed a strategy of “libertarian paternalism.” The strategy is aimed at pushing a person towards the optimal choice dictated by the mind, and not by feelings or momentary temptations.

Ask your relatives or friends to remind yourself to save 2 rubles a day, and you will not notice how you will do it yourself out of habit. Set a goal, analyze the situation and make a list of tasks that must be completed to achieve the goal. Ask different people to help control the execution of different tasks (one task – one person). For example, a colleague should make sure that you no longer buy the very fragrant muffins when you have a conversation, and let your best friend save you from going to the movies instead of jogging or courses. You will gradually see how your life is changing for the better.

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