Monday, June 2, 2008

Behavioral Economics Rides Again

"I think that betting on mistakes of people is a pretty safe bet."

"In fact, in most situations what you don't know is so overwhelmingly more important than what you do know that you have no business acting on what you know."

"The more closely you pay attention, the more you do things, the worse off you will be"

Quotes from Daniel Kahneman in, "How Thinking Costs You," Michael Rosenwald, Washington Post, May 25, 2008

We're entering the world of behavioral economics again -- the interesting brew of economics and psychology that I commented on in Who Decides Easy? Remember Nudge?

The Post article interviews Nobel Prize winner Daniel Kahneman about behavioral economics and financial investing. It inspired in me some thoughts about mistakes and community colleges.

A key concept in behavioral economics is "loss aversion." The basic idea is that we would do more and pay more to keep something we value than to obtain something new. In investment terms, people frequently hold on to losers and sell off potential winners. Think about mistakes: Why do we have such a difficult time coming clean with things that don't work out, preferring to redefine success, the appropriate metrics, or the right comparisions. There's a lot going on here but "loss aversion" certainly plays a role."

A second application of behavioral economics builds off of the idea of mutual funds -- pre packaged portfolios of stocks and bonds with varying levels of risk that we buy into. They prevent some of the mistakes that Kahneman talks about above -- the "cognitive overload" of too many choices and too much information.

James E. Rosenbaum in the article Community College: the unfinished revolution comments that "[P]rivate two-year colleges offer students a "package deal" plan for attaining an explicit career goal in a clear time frame...This strategy eliminates that problem of directionless exploration, unneeded courses, unexpected timetables..." The point is that smart institutions can make a big difference in improving college success.


Josh said...

The more I think about it, lost aversion seems like a better and better explanation of why people don't critically evaluate their own failures. It's a shame when ego gets in the way of making improvements in process.

Bob Giloth said...

Ego is a problem, certainly, but unfortunately, "loss aversion" is more a matter of our inability to do otherwise. I wonder how universal and unchangable it is? Do we always need to work around loss aversion?