Daniel Kahneman (March 5, 1934-March 27, 2024) was the psychology professor that became an economics Nobel Laureate. During the past 10 years at econlife, we have posted some of his wisdom.
These are just two examples.
Daniel Kahneman Stories
Anchors
Called an anchor, the first fact we hear influences subsequent decisions. Assume, for example, that after being told a jar has 500 jellybeans, we are asked to guess the number of candy bars in another container. Based on Dr. Kahneman’s experiments (described in Thinking Fast and Slow), people who are told the first jar has 200 beans instead of 500 answer the second question with a lower number. The reason? The first jar became an anchor that biased the second answer.
Retailers also use anchors.
Using a kitchen device to make a loaf of bread was a new idea 30 years ago. So, when Williams-Sonoma introduced one of the first bread making machines, consumers did not know how to judge its $275 price tag. After a tepid start, the company added a fancier $429 machine that was supposed to boost sales. It did. But not how they expected.
The $275 appliance sold like hotcakes.
Behavioral economists said it was all about anchoring.
For the Williams-Sonoma bread baking machine, $429 became the anchor. It biased consumers’ opinion of the $275 price tag. Sales soared because they knew they had a good deal.
Loss Aversion
Displaying loss aversion, we experience more dismay over losing a $10 bill than the happiness we feel when we find one.
I suspect though that this picture provides the perfect definition:
In a recent study about investing, we can see Dr. Kahneman’s loss aversion.
Using a pre-set strategy called their “loss-exit strategy,” investors fully planned to sell what was down and keep their wins. But they did not. Instead, they sold the winners too soon and held the losers.
The researchers looked at approximately 190,000 traders in 150 countries. Because the traders had to identify beforehand how they would manage their gains and losses, the economists could compare their plans with what they actually did. They could have, for example, been constrained by a loss limit of 10 percent and gains of 20 percent.
But here is where it gets interesting.
Investors could change their minds once they saw what how markets were performing. So, once a position sunk, rather than observing their sell commitment and acknowledging the loss, they entered a larger percent. Avoiding the recognition of a loss, their loss limit of 10 percent became, for example, 20 percent. By contrast, they tended to exit gains before the trigger set in.
Our Bottom Line: Behavioral Economics
Through behavioral economics explanations from Nobel Laureate Daniel Kahneman (2002), we can explore why it is more likely that we will behave as a human (irrationally) rather than an econ (predictably, logically, and rationally). Ranging from optimism bias to prospect theory and the endowment effect to cognitive ease, his ideas explained our decisions.
My sources and more: For much more about anchors, loss aversion, and behavioral economics, I recommend Daniel Kahneman’s Thinking Fast and Slow. But, I hope you will also remain at econlife, and reread our original posts on loss aversion and anchors And finally, this Washington Post obituary provides a detailed look at Dr. Kahneman’s rather unusual life.
