The Behavioral economics

I have a cousin abroad, who was very rational and liberal in his thoughts though he was born in an orthodox family in south Tamil nadu. He used to ask questions about the existence of god and would state that in any given day he would prefer hard work to miracles to make a person successful.  He studied computer science and went abroad to work there, and the environment made him more rational. I was a teen ager when he left to abroad and we would chat occasionally. He was a hero to me at those times, but as I grew up reading and analyzing; I find certain things does not come under this rational thinking. This idea grew stronger once I got to work on the financial sector. The study of psychology or observing trends and people’s behavior is very important to succeed in the business of money. But westerners have this tendency of taking psychology as relatively an easy thing and more often than not they always insert the notions of neuroscience being superior to psychology. That may be because the westerners always link brain functions to psychology. Unfortunately, it is more than that

The term Behavioral originated when people stated to have a close look at the happenings in their respective field and try to find a pattern. It was of a huge benefit in terms of marketing as companies knew what kind of product at what price is being bought by what sector of customers. This helped companies to plan their product design, price and launching. The term behavioral marketing is definitely the root of what is now being called as social media marketing. This became popular and spread to every other field. The term behavioral economics arose when a bunch of economists from US and UK were trying to find how people react and behave when it comes to money matters. We would see three case studies, which eventually would lead us to what the famous Behavioral economist Dan Ariely quoted as “Cognitive illusion”. Before that they tested a simple test on Chimpanzees on this behavioral thing. They had an observation that shocked them.

They tested two groups of chimpanzees with apples. The first group was given an apple, which made them extremely happy. They found chimpanzees shouting and jumping with glee inside the cage. Then they tried with another group, where they gave two apples to a chimpanzee and then they drew back one. The chimpanzees in this case were extremely disappointed and shouted at the people making very angry gestures. If one could understand chimpanzee’s language, they might have heard “What the hell? Why are you taking my apple?” This was the root cause for finding out the behavioral patterns in man about their dearest thing, which is by many case; Cash. The first case study we are going to see is done by Kahneman and Tversky. They gave people 300$ and said to them if given a choice between a) receive another 100 $ or b) tossing a coin, where if they win they would get 200$ and nothing if they lost. 99% of the people chose option a. The most interesting part is yet to come. They did another experiment, this time slightly different from the first one. They told people to imagine that they had 500$ and then asked them to chose between c) give up 100$ or d) toss a coin and pay 200$ if they lost and nothing at all if they won. Almost 100% chose option d instead of option c. So what do we get out of this? The two things are pretty similar, but the standpoint of people differ a great way. What affects the decision making skills of the people when comes to money. There could be only one logical conclusion that people are willing to take risk when it comes to loosing something rather than gaining. They don’t want to risk in gaining money. This explains the phenomenon that why an average American spends about 1000$ per year in lottery and an average Singaporean spends 4000$ in lottery. This also gives a clear idea how the share market behaves.

The next Case study we are going to see is of Dan Ariely. He in this case study tried to establish the importance of data in decision making which Is a rarity when it comes to economics are finance. People don’t give much importance to data collection as it may confuse them. They feel the less data that is available the more it is easier to decide. But this might turn bad at times, leaving out the best option we have. There was once an option came in the magazine of The Economist where it said it gives the full year digital subscription for 58$ and print subscription for 125$, the most interesting thing follows where it said both digital & print subscription for 125$ as well. Though there is no logic behind the advertisement, Dan Ariely took this issue and gave it to a set of 100 MIT students. He asked them to choose between all those three options. 28% of the people went for digital subscription, 0% for print subscription alone, and 78% went for both digital and print subscription. This seems to be a very logical decision making. So Dan Ariely continued the survey with another 100 MIT students, made just a change by removing the centre part of the survey as nobody has gone for that in the previous survey. This time there was a drastic change in the percentage, 69% of people going for digital and only 31% of the people going for both digital and print subscription. So this makes a point very clear that even though the second option has not got any value, it clearly affect the decision made by the people. So by this case study Dan emphasized the value of datas while making decision financially.

The third case study is also done by Dan Ariely, where he talks about the power of zero or can we say the power of free. In a busy road a chocolate from Cadbury’s company was sold for 15 cents per chocolate instead of one dollar and another local handmade chocolate for one cent. People when given a chance to make a choice between those two, people chose Cadbury’s that was given at a good discount rather than the one cent local chocolate. But when one cent is slashed on both chocolates, i.e. Cadbury’s chocolate sold for 14 cents and the local chocolate sold for free, most people abandoned the brand of Cadbury’s and went for local chocolate.

These case studies teach us three important things about the behavioral economics about human

  1. They choose free over brand
  2. They choose with the options they are given, instead of looking for more data.
  3. They are willing to gamble more on loses than to gamble with gains.

These case studies would help anyone who is new to invest in share market. These actually give the road map of how things are going in the equity market. To know more about finance management and portfolio management click here. We would be more than happy to have a conversation in our facebook page.

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