Key points and learnings about Misbehaving

Homo Economicus

Richard sets the tone for the book with the birth of the “Homo Economicus” and also the wit which the rest of the book follows. He says economists have replaced homo sapiens with a fictional creature called the ‘Homo economicus” and continues to shorten this to “Econs”. His point is a valid one: economists have created Econs to be rational and to always make the best logical decision, considering all available information and alternatives. However, he argues that: “Humans do a lot of misbehaving and that means the economic models make a lot of bad predictions”.

The primary reason for incorporating humans into economic theory is to improve prediction accuracy. Still, it also makes economics interesting: “Behavioural economics is more interesting and more fun than regular economics. It is the un-dismal science”
However, Richard is at pains to stress that we do not need to throw out everything we know about how economies and markets work. But we do need to stop inventing abstract models that describe the behaviour of imaginary Econs and start paying attention to those “supposedly irrelevant factors” (SIFs).

Mental Accounting

The second part of the book concentrates on what behavioural economists refer to as ‘mental accounting’ although Richard started off referring to it as ‘psychological accounting’. Richard first examines Opportunity Cost Theory and concludes that, while Econs make decisions by analysing all possible alternatives, in reality, humans cannot compute an infinite number of alternatives and, at most, will select a couple to choose from.

Humans don’t just think in terms of number and utility maximisation, but also take into account the perceived quality of the deal. Transaction utility explains why people sometimes never buy something that would give them great memories for a lifetime. Because, irrationally, they feel it’s not a good deal, and they don’t want to live with the feeling of having overpaid. On the other hand, we often buy things we won’t even use because we feel they’re a great bargain. This is why shops always run fake sales: to give people the feeling they are getting a bargain. Econs, instead, would never experience transaction utility.

Placebo Effect

In the next part of the book, Richard continues his attack on the weaknesses of economic theories, offering more examples and proofs that humans are not rational decision-makers.

Richard also tackles what he refers to as the field where the “homo economicus” was strongest and most entrenched, the financial markets. With all the big banks and all the money at stake, financial markets had to be efficient. So if psychology and behavioural finance could prove that financial markets are irrational, then the evidence could no longer be ignored. And he provides plenty of examples to show how irrational financial markets are.

The book then moves to the present day and explores how behavioural economics is affecting our lives and entertainment. Richard covers two popular game shows, Deal or No Deal and Golden Balls, and explores the psychological experiment behind the two shows. Both shows demonstrate human irrationality and bring behavioural economics to life.