Nudge Ch2 - Summary

Nudge – Chapter 2

This chapter is taken from the book Nudge: Improving Decisions About Health, Wealth, and Happiness by the economist Richard H. Thaler and Cass Sunstein (Harvard professor). Nudge discusses how public and private organizations can help people make better choices in their daily lives.

Richard H. Thaler is an American economist and a Distinguished Service Professor of Behavioral Science and Economics at the University of Chicago Booth School of Business.

In 2017, he was awarded the Nobel Memorial Prize in Economic Sciences for his contributions to behavioral economics. In its Nobel prize announcement, the Royal Swedish Academy of Sciences stated that his "contributions have built a bridge between the economic and psychological analyses of individual decision-making”.

Resisting temptation

Temptation

·         The cashew phenomenon

The chapter is introduced by a fact that could happen to any of us. Thaler invites friends to dinner, disposes of a bowl of cashew nuts as an aperitif, but ends up taking it away fearing that the guests will finish it and no longer have the appetite to eat.

Once he brought the bowl back to the kitchen, the guests who were devouring the nuts thanked him for doing so.

In economics (and in ordinary life), a basic principle is that you benefit from having as many choices as possible, because you can always turn them down. Before Thaler removed the nuts, the group had the choice of whether to eat the nuts or not—now they didn’t.

In the language of economics, the group is said to display behavior that is dynamically inconsistent. At first, people prefer to eat just a few nuts to whet their appetite, but over time, they are tempted to eat more, even if they are no longer hungry. So, initially people prefer A to B, but they later choose B over A.

·         Hot & Cold state

In this situation there are two important concepts: temptation and mindlessness.

Temptation can be defined by hot and cold states. You are in a hot state when you are hungry and that you smell some food, while when you are only thinking of what you’ll eat in two days, you are in a cold state. We will call something “tempting” if we consume more of it when hot than when cold.

To take back Ulysses example, he instructed his crew to fill their ears with wax so that they would not be tempted by the sirens in a cold state to prevent themselves from succumbing while they will be in a hot state.

Ulysses succeeds in not succumbing, but in reality, men underestimate the power of temptation when they are in a cold state and that is why he easily fails once he is in a hot state.

For example, you go to a party thinking you're not going to drink, and then when someone offers you a drink you accept it.

·         Far-sighted “Planner” and a myopic “Doer.”

Self-control problems can be illuminated by thinking about an individual as containing two semiautonomous selves, a far-sighted “Planner” and a myopic “Doer.” We're good at planning as long as we're on the back foot and then as soon as we get to the situation, we take action.

Studies in neuroeconomics have shown that some parts of the brain get tempted, and other parts are prepared to enable us to resist temptation by assessing how we should react to the temptation. Sometimes the two parts of the brain can be in severe conflict—a kind of battle that one or the other is bound to lose.

Mindless Choosing

In many situations, people put themselves into an “automatic pilot” mode, in which they are not actively paying attention to the task at hand.

What was true for the cashews is also true for the popcorn. An experiment in Chicago involved giving 5 days' old popcorn to spectators and giving half of them large buckets and the rest medium ones. Despite the horrible taste, those with the big one ate 53% more on average, showing that the brain had become disconnected.

The same thing was done with bowls of soup that never emptied (it filled up automatically) and people never stopped eating.

When self-control problems and mindless choosing are combined, the result is a series of bad outcomes for real people, like the millions of people who smoke knowing it's harmful.

Self-Control Strategies

Since people are at least partly aware of their weaknesses, they take steps to engage outside help. In these cases, our Planners are taking steps to control the actions of our Doers. Unfortunately, Doers are often difficult to control. As when you set up an alarm in order to wake up early, but that you go back to sleep when you hear it in the morning.

Clocky, an ingenious alarm clock, has been invented, and moves around the room ringing to force you to get up.

Planners have a number of available strategies, such as Clocky, to control recalcitrant Doers, but they can sometimes use some help from outsiders. We will be exploring how private and public institutions can provide that help.

1.       People together:

Thaler once set up an ingenious system with a student who couldn't make any progress in writing his thesis: David, the student, would write Thaler a series of checks for $100, payable on the first day of each of the next few months. Thaler would cash each check if David did not put a copy of a new chapter of the thesis under his door by midnight of the corresponding month.

Furthermore, Thaler promised to use the money to have a party to which David would not be invited. David completed his thesis on schedule four months later, never having missed a deadline.

Sometimes friends can adopt such type of betting strategies together too. Two students made a pact. Each agreed to lose thirty pounds over a period of nine months. If either failed, he had to pay the other $10,000. The bet was a big success; both met their target.

2.      Governments:

In some situations, people may even want the government to help them deal with their self-control problems. In extreme cases, governments might ban some items (such as heroin use, prostitution, and drunken driving).

One interesting example of a government-imposed self-control strategy is daylight saving time.

Indeed, surveys reveal that most people think that daylight saving time is a great idea, primarily because they enjoy the “extra” hour of daylight during the evening. Of course, the number of daylight hours on a given day is fixed and setting the clocks ahead one hour does nothing to increase the amount of daylight.

3.       Markets:

In many cases, markets provide self-control services, and government is not needed at all. An interesting example is a distinctive financial services institution that used to be quite popular: the Christmas savings club.

In November (around Thanksgiving) a customer opens an account at her local bank and commits herself to depositing a given amount (say $10) each week for the next year. And even if you lose liquidity (can’t withdraw), pays high transaction costs and earn no return, people were doing it. Now with credit card, things have changed.

Mental Accounting

Another way to approach these problems is to adopt internal control systems, otherwise known as mental accounting.

Mental accounting is the system (sometimes implicit) that households use to evaluate, regulate, and process their home budget. Almost all of us use mental accounts, even if we’re not aware that we’re doing so.

One of the most creative examples of mental accounting was invented by a finance professor we know (Thaler). At the beginning of each year, he designates a certain amount of money (say $2,000) as his intended gift to the United Way charity. Then if anything bad happens to him during the year—a parking ticket, for example—he mentally deducts the fine against the United Way gift. This provides him “insurance” against minor financial mishaps.

Same thing with gamblers at the casino, who are separating their original money from the “house money”, the money they earned playing, that they will gamble easily.

For each of us, using mental accounts can be extremely valuable. They make life both more fun and more secure. Many of us could benefit from a near-sacrosanct “rainy day” account (in case of unplanned expenses) and from a freely available “entertainment and fun” account.