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2013-05-02 13:46:02
A Nobel prizewinner argues for an overhaul of the theory of consumer choice
Apr 27th 2013 |From the print edition
SOVEREIGN in tastes, steely-eyed and point-on in perception of risk, and
relentless in maximisation of happiness. This was Daniel McFadden s memorable
summation, in 2006, of the idea of Everyman held by economists. That this
description is unlike any real person was Mr McFadden s point. The Nobel
prizewinning economist at the University of California, Berkeley, wryly termed
homo economicus a rare species . In his latest paper* he outlines a new
science of pleasure , in which he argues that economics should draw much more
heavily on fields such as psychology, neuroscience and anthropology. He wants
economists to accept that evidence from other disciplines does not just explain
those bits of behaviour that do not fit the standard models. Rather, what
economists consider anomalous is the norm. Homo economicus, not his fallible
counterpart, is the oddity.
To take one example, the people in economic models have fixed preferences,
which are taken as given. Yet a large body of research from cognitive
psychology shows that preferences are in fact rather fluid. People value
mundane things much more highly when they think of them as somehow their own :
they insist on a much higher price for a coffee cup they think of as theirs,
for instance, than for an identical one that isn t. This endowment effect
means that people hold on to shares well past the point where it makes sense to
sell them. Cognitive scientists have also found that people dislike losing
something much more than they like gaining the same amount. Such loss aversion
can explain why people often pick insurance policies with lower deductible
charges even when they are more expensive. At the moment of an accident a
deductible feels like a loss, whereas all those premium payments are part of
the status quo.
Another area where orthodox economics finds itself at sea is the role of memory
and experience in determining choices. Recollection of a painful or pleasurable
experience is dominated by how people felt at the peak and the end of the
episode. In a 1996 experiment Donald Redelmeier and Daniel Kahneman, two
psychologists, showed that deliberately adding a burst of pain at the end of a
colonoscopy that was of lower intensity than the peak made patients think back
on the experience more favourably. Unlike homo economicus, real people are
strongly influenced by such things as the order in which they see options and
what happened right before they made a choice. Incorporating these findings
into models of consumer behaviour should improve their power to predict
everything from which loans people choose to which colleges they apply for.
Trust is something economists already incorporate into their models. But trust
turns out to be not just a function of history and interactions, as dismal
scientists tend to think, but also a product of brain chemistry. Pumping people
with oxytocin, the so-called love hormone , has been found to make them much
more generous in games where they have to decide how much of their money to
entrust to another person who has no real incentive to return any of it.
Sovereign, indeed.
Much of this may be alien to modern-day economists, but it is in line with the
conception that other disciplines have of human decision-making. Psychologists
have long known that people s choices and preferences are influenced by others.
Biologists have a much clearer understanding of altruism and kindness, whether
to kin or strangers, than economists, who typically emphasise the dogged
pursuit of self-interest. This way of thinking would also have been
recognisable to their intellectual forefathers. Adam Smith wrote extensively
about the central role of altruism and regard for others as motivators of human
behaviour. The idea of loss aversion would have made sense to Jeremy Bentham,
the founder of utilitarianism: he spoke of increased pleasure and reduced pain
as two distinct sources of happiness.
Mr McFadden believes that economists need to do things differently if they are
truly to understand how people make decisions. Manipulating brain activity is
one way of delving into where economic choices really come from. Analysing the
information people get through social networks would help them understand the
role of influence and identity in decision-making.
Such tools have implications for policy. Plenty of poor people in America are
wary of programmes like the Earned Income Tax Credit (EITC) because the idea of
getting a handout from the government reinforces a sense of helplessness.
Dignity is not something mainstream economics has much truck with. But creating
a sense of dignity turns out to be a powerful way of affecting decisions. One
study by Crystal Hall, Jiaying Zhao and Eldar Shafir, a trio of psychologists,
found that getting poor people in a soup kitchen to recall a time when they
felt successful and proud made them almost twice as likely to accept leaflets
that told them how to get an EITC refund than members of another group who were
merely asked about the last meal they had eaten.
A nudge and a think
Taking the path Mr McFadden urges might also lead economists to reassess some
articles of faith. Economists tend to think that more choice is good. Yet
people with many options sometimes fail to make any choice at all: think of
workers who prefer their employers to put them by default into pension plans
at preset contribution rates. Explicitly modelling the process of making a
choice might prompt economists to take a more ambiguous view of an abundance of
choices. It might also make them more sceptical of revealed preference , the
idea that a person s valuation of different options can be deduced from his
actions. This is undoubtedly messier than standard economics. So is real life.