Chapter 8 - Behavioral economics: A closer look at decision making. In this chapter you will learn: What time inconsistency is and how it accounts for procrastination and other problems with selfcontrol, why sunk costs should not be taken into account in deciding what to do next, what types of opportunity cost people often undervalue and why undervaluing them distorts decision making,. | Chapter 8 Behavioral Economics: A Closer Look at Decision Making © 2014 by McGraw-Hill Education 1 What will you learn in this chapter? • What time inconsistency is and how it accounts for procrastination and other problems with selfcontrol. • Why sunk costs should not be taken into account in deciding what to do next. • What types of opportunity cost people often undervalue and why undervaluing them distorts decision making. • What fungibility is and why it matters in financial decision making. © 2014 by McGraw-Hill Education 2 Scenario 1: When are sunk costs sunk? • Suppose you buy a ticket to attend a concert for $20. Upon arriving, your ticket is not in your pocket. How do you react? 1. “Oh well, I’ll just buy another ticket for $20.” 2. “No way, I’m not going to spend $40 on this concert! I’d rather go do something else instead.” 54% of people indicated they would react like 1. 46% of people indicated they would react like 2. © 2014 by McGraw-Hill Education 3 1 Scenario 2: When are sunk costs sunk? • Now suppose you arrive at the concert and you are missing $20. How do you react? 1. “Oh well, I’ll just buy a ticket for $20.” 2. “You know what? Forget the concert.” 88% of people indicated they would react like 1. 12% of people indicated they would react like 2. © 2014 by McGraw-Hill Education 4 When are sunk costs sunk? • Scenarios 1 and 2 are identical. – You arrive at a concert intending to see a concert. – You have $20 less than you expected. • If you are short on cash, it makes sense to skip the concert. • If you are not short on cash, why does it matter if you lost a $20 bill before or after you’d converted it into a concert ticket? – This is not rational behavior. – Emotionally, however, it seems to matter for some. • Behavioral economics studies why individuals appear to act irrationally by studying insights from psychology. © 2014 by McGraw-Hill Education 5 Dealing with temptation and procrastination • Individuals struggle against .
