If you were to ask an economist. How do you know that cost benefit theory and its corollaries of sunk cost and opportunity cost are the way to live your life. How do you know that's the right way to handle your finances and the way you organize yourself? Economists will say well, it can be mathematically proved from the axioms of cost-benefit theory. And corporations pay for decision analysts. Is that convincing to you? It's not to me. Logical consistency doesn't prove practical utility. And remember, optimizing was considered the thing to do until Simon came along and said no it's satisfied, satisfies him you ought to be doing. And corporations do pay for decision analysts, but they also pay for handwriting analysts, lie detectors, motivational speakers to hop around a stage and tell jokes. And they hire on the basis of interviews. What if you knew though, that the greater your familiarity with cost-benefit principles, the more likely you are to use them, that's including the some cost principle and the opportunity cost principle well, in fact, I know from research I've done, economists are much more likely to live their lives in line with cost-benefit theory than other professors at my university. Students who've had an economics course do a little better. Not much. And, as a matter of fact, you've learned much more in this little lesson today, then students get from an entire microeconomics course, the text used at my University has precisely one example of some cost, and it's not even a very good example. When I teach the principles and this is important to deciding whether they're right or not, it has an impact on people. I know that because weeks later, I test you know how they make their decisions in context they don't even know they're in a psychology experiment. And it has an impact. And finally, people who report making the kinds of decisions that are encouraged by cost benefit theory do better in life. At any rate, professors live their lives in accord with cost-benefit theory, make more money and get higher raises. Students who live their lives in light of cost-benefit theory get higher grades. Including higher grades then they should get. Based on their entrance exam aptitude scores. The overachievers are people who overuse, so to speak, cost benefit theory. And that makes sense because violations of sunk cost and opportunity cost principles usually involving wasting time or resources. Well, a final topic I want to discuss is some foibles that have been discovered by people who work in a discipline at the margin of economics and psychology, and they've discovered choice and decision quirks that cost money, and sometimes even lives, suppose you need some money and you have to sell one of the two stocks that you own. Which stock should you sell? One that's been going down in hopes that the one that's going up will keep going up? Or one that's been going up so that you won't lock in your losses on the stock that's going down? Most people say, they sell the one that's going up. But selling your winners and keeping your losers leads to the poorhouse. Whether you retire rich or not rich, poor or not poor depends on making sure that you keep winning stocks and get rid of losing stocks. Suppose that out of the kindness of my heart, I give you 100 dollars, and then I say, I'm a betting man. I propose we have a bet here. I'm going to let you toss the coin and If it comes up heads, you give me back that $100. So you don't have anything. If it comes up tails, you get to keep that $100 I gave you, plus X, some amount of additional money. What would X have to be in order for you to take that bet? Notice that 0 would be fair. That's $100 versus $100. Even one dollar would be in your favor. That's $100 versus $101 dollars. That's a bet with an expected value of $0.50, one-half times $1. What amount would tip you over to take that bet? $5? $10? $20? The average that people hold out for is $100. If you don't take the bet at $99, you've thrown away $49.50. That's one half times 99. So, why do people makes these kinds of mistakes? It's because of something called loss aversion. A loss seems to be about twice as painful as the same gain is pleasurable. This cause people to forego lots of opportunities that they shouldn't forego. People pick the wrong stock to sell, because if they pick the one that's going up, which they probably know is going to continue to go up. They lose some money for sure. People hold out for a ridiculous amount of money on that $100 bet because the prospect of loss is so costly, psychologically. Loss aversion underlies what's called the endowment effect. People demand more money for a thing than they paid for it. Often a lot more. Imagine you paid $50 for a ticket for a football game and a couple of days before the game tickets are selling for a lot more than there face value, suppose you see offers of $200 for your ticket on the Internet. Would you sell? Maybe not. But you should, if the game was worth no more than $50 for you initially, and things haven't really changed you should be willing to sell that ticket. The following experiment has been done by now hundreds of times in business schools. You give half of the students in the class a mug with the school logo on it and you ask the other half how much they would pay one of the owners in the room to get their mug. And you ask the owners how much they would demand to get to sell their mug. Owners demand twice as much as non-owners are willing to pay. So I didn't really care all that much about that coffee mug. And you give it to me now. That's great. I'm going to keep this thing. Don't try to take it away from. My university's musical society did a fascinating experiment recently. They advertised a new concert series, and they included in the envelope either a letter with a promo code for $20, and you get $20 off the series if you, if you tell people this promo code. Or they gave them a piece of paper which said, $20 voucher. They got 70% more people buying the concert series with the voucher. Then with the promo code. So I can tear up that letter or promo code, the heck with it. The $20 voucher, I'm going to tear up this $20 voucher, [LAUGH] it doesn't seem reasonable. So, the bottom line for all of this is what am I losing to avoid this loss? Just how much do I really want this mug, the soccer ticket. Am I buying this thing just because I got a discount? And retailers should take notice of give coupons not promo codes. The last topic I want to discuss is what the behavioral economists call choice architecture. You might be surprised to know that only 12% of Germans allow harvesting of their organs for use for other people in the event of their death. 99% of Austrians allow harvesting of their organs. Bet you never would have guessed how much nicer and more generous Austrians are than Germans. Well actually, we have no reason to assume. There's any difference. The difference is that for in Germany, you have to check a box if you are willing to donate your organs. And then Austria, you have to check a box if you're not willing to donate your organs. That results in a huge difference in compliance. Or here's another example of the same point. Sometimes, some people are hired on a job. One of the forms they have to fill out, they have to check a box if you want the company to contribute money to your retirement account. Or they have you check a box if you don't want the company to contribute to your retirement. That's the difference between 20% people signing up initially and 90%. So, how much choice is enough? I have a German friend who came to work in my department. And after he'd been here for a while he said, why do you Americans need 50 kinds of breakfast cereal? I didn't have an answer. Retailers, at least in America, consistent with good economic theory give people lots of choice. The Coca-Cola company thinks you want a lot of choices, that's for sure. Which do you prefer, Coca-Cola, Diet Coke, Coca-Cola Light, caffeine free Coca-Cola, caffeine free Coke, caffeine free Coca-Cola Light, Cherry Coke, Coke Zero, Vanilla Coke, Diet Vanilla Coke, Diet Cherry Coke, or Diet Coke with Lime, in a green can by the way. Or maybe you'd really just rather have a Dr Pepper. There's an upscale grocery store in Silicon Valley, which offers 75% of all olive oil. 250 types of mustard. 300 types of jam and social psychologists set up a tasting table to see do people really want all this choice? How well does the retailer do? We've given people a huge amount of choice versus a small amount. So they set up a tasting table which either some days had six types of jam on it and other days had 24 types of jam on it. Ten times as many people bought a jar, if there were only six types of jam at the tasting table. So there are two morals here. Don't overestimate people's willingness to consider alternatives. There's a cost to that, that can result in big losses. In the next lesson, we'll talk about two very different approaches to critical thinking: logic and dialectical reasoning.
