2017 Nobel Prize in Economics12/10/17
On 10 December 1896, Alfred Nobel died, bequeathing his will to the creation of the Nobel Prizes so that his estate could be used ‘For the greatest benefit to mankind’.
Unfortunately for the economic sciences, it wasn’t present in the original five categories or Physics, Chemistry, Physiology, Literature, and Global Fraternity (Peace) specified by Alfred Nobel. As such the Nobel Prize in Economics correct name is The Sveriges Riksbank Prize in Economic Sciences in memory of Alfred Nobel, first awarded in 1968, although it is understandable why this much lengthier title hasn’t caught on. Never the less this award is still chosen via the same rigorous system as the other categories; the recipient is given a gold medallion by the Monarch of Sweden and the approximately AUD 1.1M, the same as the original five categories.
Something else that sets the prize in economics apart from is siblings is what the recipient’s body of work represents. For Physics, Chemistry, Physiology, Literature, and Peace it is the pinnacle of a lifetimes work that represents the next leap in their respective fields. While this is, of course, the same for the prize in economics, the subject matter that ultimately merits the awarding is usually much more contemporary in the economic world, highlighting what the field will most likely place in high regard over the next few years.
The 2017 and 49th Winner of The Sveriges Riksbank Prize in Economic Sciences in memory of Alfred Nobel is Richard H Thaler from the University of Chicago for his pioneering work in behavioural economics.
As anyone who has studied introduction to economics knows, one of the first assumptions made by any model is that a person is rational. The hypothesis for the model details that everyone is making decisions that result in the most optimum level of benefit or utility for themselves. Now as anyone who has spent time in a shopping centre carpark knows, this isn’t always the case. Enter Richard Thaler and the field of behavioural economics.
Professor Thaler’s Nobel Prize-winning research introduces five major deviations from the traditional models:
Our Rationality is Bounded
Prof Thaler’s theory suggests that human’s ability to be rational has limits, an excellent example of this argument is Mental Accounting. The Mental Accounting phenomenon where people simplify their financial decisions by mentally segregating their money into separate accounts, focusing on the small impacts rather than the overall effect. A primary example of this is a person having $500 in a savings account with an interest rate of 2.5% and $500 on a credit card with a rate of 19% it makes financial sense to pay off the card with the savings. However, a lot of people don’t do this fearing they won’t replace the money in their savings account.
This theory states that people will penalise you for what they perceive to be unfair behaviour. This argument is manifest through companies not raising prices in times of high demand, but raising them when costs go up. Another simple example for this theory is the umbrella scenario. This scenario says that a store that sells umbrellas for $10 won’t raise their prices to $15 in a thunderstorm for fear of public backlash, however, if their costs for making the umbrellas go up by $5 they would raise their price to $15.
Lastly, this theory will finally shed light on why almost everyone that is reading this bought a gym membership in January, and has only gone twice between then and now despite it being October. The planner-doer model is the economist’s take on the eternal struggle of the long-term/short-term planning. The planner is all of us rationalises the cost of that yearly gym membership based on continued use. The doer is the side of us that fails to take the short-term initiative to turn trips to the gym into a long-term habit. The same concept is behind why many of us fail to prepare for our retirement
This theory states that people place a higher value on things they possess over things they do not and is the subject of one of Prof Thaler’s more famous experiments. In this research, Prof Thaler and his colleagues give mugs to half of the students in a classroom and instruct them to open a mug market. Those students who received a mug valued them at twice the price than those who didn’t. This effect is also manifest in any action where you find it hard to cut your losses from a poor investment/decision.
The Hot-Hand Fallacy
Lastly, we have the hot-hand fallacy and who better to explain it than Selina Gomez. With a little help from Prof Thaler himself from their cameo in The Big Short.
Prof Thaler’s theories can help you save money, avoid price gouging, and save time on that gym membership by just admitting that you were never going to go. Unfortunately/fortunately, Prof Thaler and Behavioural Economics aren’t done yet, as this topic cannot be discussed adequately without mentioning the Nudge theory.
The Nudge Theory
At its most basic principals, the nudge theory is simple. However, it’s one that can have far-reaching consequences into everyday life. The nudge theory is a relatively subtle shift in policy that encourages people to make decisions now, that will benefit themselves or their society in the future. Examples of this theory are already at work around the globe, from Spain’s opt-out organ donor policy making them a world leader in transplants to the UK’s opt-out retirement contribution scheme. These shifts can be even smaller, again in the UK it was found that people are more likely to pay registration on their vehicle, objectively the right decision for the individual and the broader community if a picture of their car was included on the bill, so that is what the government started doing.
For all of us from the land girt by sea, we have the Federal Government unit, The Behavioural Economics Team of the Australian Government or Nudge Unit already helping our State-of-Origin challenged countrymen to complete their apprenticeship and improve hospitality patients experience.
In conclusion, well-deserved congratulations to Prof Thaler and an exciting topic that is already having a real impact on the world.