Misbehaving: The Making Of Behavioral Economics

To: Victor Fuchs who gave me a year to think, and Eric Wanner and the Russell Sage Foundation who backed a crazy idea And to: Colin Camerer and George Loewenstein, early students of misbehaving CONTENTS Preface I. BEGINNINGS: 1970–78 1. 2. 3. 4. 5. 6. Supposedly Irrelevant Factors The Endowment Effect The List Value Theory California Dreamin’ The Gauntlet II. MENTAL ACCOUNTING: 1979–85 7. 8. 9. 10. Bargains and Rip-Offs Sunk Costs Buckets and Budgets At the Poker Table III. SELF-CONTROL: 1975–88 11. Willpower? No Problem 12. The Planner and the Doer INTERLUDE 13. Misbehaving in the Real World IV. WORKING WITH DANNY: 1984–85 14. What Seems Fair? 15. Fairness Games 16. Mugs V. ENGAGING WITH THE ECONOMICS PROFESSION: 1986–94 17. 18. 19. 20. The Debate Begins Anomalies Forming a Team Narrow Framing on the Upper East Side VI. FINANCE: 1983–2003 21. 22. 23. 24. 25. 26. The Beauty Contest Does the Stock Market Overreact? The Reaction to Overreaction The Price Is Not Right The Battle of Closed-End Funds Fruit Flies, Icebergs, and Negative Stock Prices VII. WELCOME TO CHICAGO: 1995–PRESENT 27. 28. 29. 30. Law Schooling The Offices Football Game Shows VIII. HELPING OUT: 2004–PRESENT 31. Save More Tomorrow 32. Going Public 33. Nudging in the U.K. Conclusion: What Is Next? Notes Bibliography List of Figures Acknowledgments Index The foundation of political economy and, in general, of every social science, is evidently psychology. A day may come when we shall be able to deduce the laws of social science from the principles of psychology. —VILFREDO PARETO, 1906 PREFACE Before we get started, here are two stories about my friends and mentors, Amos Tversky and Daniel Kahneman. The stories provide some hints about what to expect in this book. Striving to please Amos Even for those of us who can’t remember where we last put our keys, life offers indelible moments. Some are public events. If you are as old as I am, one may be the day John F. Kennedy was assassinated (freshman in college, playing pickup basketball in the college gym). For anyone old enough to be reading this book, September 11, 2001, is another (just getting up, listening to NPR, trying to make sense of it). Other events are personal: from weddings to a hole in one. For me one such event was a phone call from Danny Kahneman. Although we speak often, and there are hundreds of calls that have left no trace, for this one I know precisely where I was standing. It was early 1996 and Danny had called to share the news that his friend and collaborator Amos Tversky was ill with terminal cancer and had about six months to live. I was so discombobulated that I had to hand the phone to my wife while I recovered my composure. The news that any good friend is dying is shocking, but Amos Tversky was just not the sort of person who dies at age fifty-nine. Amos, whose papers and talks were precise and perfect, and on whose desk sat only a pad and pencil, lined up in parallel, did not just die. Amos kept the news quiet until he was no longer able to go into the office. Prior to that, only a small group knew, including two of my close friends. We were not allowed to share our knowledge with anyone except our spouses, so we took turns consoling one another for the five months that we kept this awful news to ourselves. Amos did not want his health status to be public because he did not want to devote his last months to playing the part of a dying man. There was work to do. He and Danny decided to edit a book: a collection of papers by themselves and others in the field of psychology that they had pioneered,