Per-Hour Learning Potential /Utility: ★★★★★★★ (7/7)
Readability: ★★★★★★★ (7/7)
Challenge Level: 2/5 (Low) | ~350 pages ex-notes (432 official)
Blurb/Description: Nobel prize winner Richard Thaler – one of the fathers of behavioral economics – delivers an extraordinarily learning-rich, supremely funny journey through the evolution of behavioral economics.
Summary: Misbehaving is my favorite book of all time. And it’s not even close. (In case you’re wondering, Don Norman’s The Design of Everyday Things – DOET review + notes – owns the #2 slot, and Dr. Matthew Walker’s “ Why We Sleep” – Sleep review + notes – gets the title of “most important book.”)
Misbehaving is a twofer: it is far and away the best book about cognitive biases (slightly edging out Jerome Groopman’s How Doctors Think – HDT review + notes), as well as a phenomenal book about the good parts of classical economics (like sunk costs, marginal utility, opportunity costs, incentives, and so on).
Beyond providing a thorough grounding in the theory, it provides a phenomenal practical application by making it stunningly clear how many classical economists were, in fact, falling prey to the same incentives-driven local vs. global optimization problems, and the adherence to ideology and susceptibility to cognitive biases that make us all humans instead of econs.
I consider it a grave crime against humanity that Daniel Kahneman’s appallingly poorly-written, depressing, academic Thinking Fast and Slow (TFS review) is the “default” recommendation in the cognitive biases space. Nobody ever talks about Thaler’s two masterpieces, Misbehaving and Nudge (Ndge review + notes) – which are infinitely superior.
Why do they beat the pants off Thinking Fast and Slow? Easy. Kahneman prides himself on being a pessimist, and it shows: TFS displays little to no interest in practical applications (because he holds the nihilistic and demonstrably incorrect belief that we can’t modify our schema); he also has the tedious, dry, repetitive writing style unfortunately all too common among academics. In sharp contrast, Thaler has all the qualities of good teachers: witty, practical, concise, and optimistic.
Highlights: Richard Thaler is hilarious. Full stop. With a range from mischievous to self-deprecating to sarcastic, he is funnier than many professional stand-up comics. There is more personality in Misbehaving alone than in my next nine favorite books combined.
Moreover, as you might be able to tell by the number/depth of my notes, the return-on-time-invested here with regards to learning is literally off the charts: I always get something new out of rereading Misbehaving, even though I consider myself pretty familiar / well-versed in its subject material. Misbehaving provides a practical, usable overview of many of the core concepts from traditional economics (like incentives, opportunity costs, and utility) while tying those in with newer behavioral economics concepts drawn from psychology.
Very very rarely do you get to enjoy yourself this much while learning a ton. So savor Misbehaving, and do it often.
Lowlights: There is very little to dislike here. Some of the material may be a tiny bit repetitive for those who’ve already read Nudge, but most of it is substantially different; also, some of the chapters at the end (see Reading Notes) can be skipped if you want.
My only real quibbles with Thaler are minor: sometimes I think there are other concepts at play that he doesn’t reference explicitly, and there is his brief reference to the Shiller P/E, which I think (with good empirical basis) is a totally dumb, completely nonsensical and useless metric. However, this is one minor disagreement in an otherwise flawless ~350-page book.
And also, let’s be real: cashews are the worst nuts. This would be an eight-star book if not for Thaler’s terrible taste in nuts. 😉
Mental Model / ART Thinking Points: pretty much all of them. humans vs. econs, utility, constrained optimization, hot-cold empathy gap, sunk costs, opportunity costs, salience bias, theendowment effect, contrast bias, hindsight bias, loss aversion, availability heuristic, status quo bias,commitment bias, incentives, local vs. global optimization, product vs. packaging, fungibility, social proof, discount rates, hyperbolic discounting / present bias, path-dependency, trait adaptivity, principal-agent problems, schema, willpower depletion, structural problem solving, activation energy, habit, fairness, confirmation bias, commitment bias, man with a hammer, ideology,reciprocity bias, base rates / inside/ outside view, expected value, luck, memory, n-order impacts,the halo effect, overconfidence.
You should buy a copy of Misbehaving: The Making of Behavioral Economics if: you have a pulse, or even if you don’t (I’d like to be buried holding a copy of Misbehaving, for the record). Okay, I’ll be serious: if you’re interested in extremely thoughtful analysis of cognitive biases, structural problem solving, and good life decision making / business management and investing practices, all wrapped up in a compelling, funny, engaging story about the development of a new field of study, you’re in for a treat.
Reading Tips: Readers who are familiar with Nudge may find some parts (such as the brief discussion of Save More Tomorrow late in the book) to be repetitive and these can be skimmed/skipped; also, readers who are well-versed in the flaws of the efficient market hypothesis might consider skimming the section of the book that relates to finance, as you likely take it as already obvious that the EMH is nonsense. Finally, the NFL draft and game-show chapters should be viewed as “optional” – read if you have the time/interest, but you’ll have gotten the message by that point if you haven’t.
Thaler, in a rare twist, acknowledges that you should only read the book until it stops being fun. With a twinkle in his eye, he reminds the reader that to do otherwise… would just be misbehaving.
Nudge by Cass Sunstein and Richard Thaler (Ndge review + notes). This is a masterful book, with 100 pages of hard-hitting theoretical learning, and various applications of the “structural problem solving” approach similar to that of Don Norman’s “human-centered design.” Nudge is a clinic in real-world problem solving for humans.
How Doctors Think by Jerome Groopman (HDT review + notes). This is my second-favorite book on cognitive biases; what it lacks in terms of comprehensiveness and theoretical depth, it makes up for in terms of a phenomenally practical, applied approach. Totally under the radar, and totally awesome.
The Design of Everyday Things by Don Norman (DOET review + notes). Thaler cited DOET as the “breakthrough organizing principle” for Nudge, and it’s a truly world-class book, not only providing a coherent and useful worldview, but also a lot of learning about important topics like memory along the way.
Seeking Wisdom by Peter Bevelin ( SW review + notes).
Another great book on various ways our thinking can go wrong.
Superforecasting by Philip Tetlock (SF review + notes). I think Superforecasting ties in really well after Misbehaving, as it provides an opportunity to think about how all of the biases impact our ability to make good predictions (and thus good decisions).
This video interview of Thaler being funny, and completely destroying Eugene Fama in a discussion about market efficiency.
Reread Value: 5/5 (Extreme)
More Detailed Notes + Analysis (SPOILERS BELOW):
IMPORTANT: the below commentary DOES NOT SUBSTITUTE for READING THE BOOK. Full stop. This commentary is NOT a comprehensive summary of the lessons of the book, or intended to be comprehensive. It was primarily created for my own personal reference.
Much of the below will be utterly incomprehensible if you have not read the book, or if you do not have the book on hand to reference. Even if it was comprehensive, you would be depriving yourself of the vast majority of the learning opportunity by only reading the “Cliff Notes.” Do so at your own peril.
I provide these notes and analysis for five use cases. First, they may help you decide which books you should put on your shelf, based on a quick review of some of the ideas discussed.
Second, as I discuss in the memory mental model, time-delayed re-encoding strengthens memory, and notes can also serve as a “cue” to enhance recall. However, taking notes is a time consuming process that many busy students and professionals opt out of, so hopefully these notes can serve as a starting point to which you can append your own thoughts, marginalia, insights, etc.
Third, perhaps most importantly of all, I contextualize authors’ points with points from other books that either serve to strengthen, or weaken, the arguments made. I also point out how specific examples tie in to specific mental models, which you are encouraged to read, thereby enriching your understanding and accelerating your learning. Combining two and three, I recommend that you read these notes while the book’s still fresh in your mind – after a few days, perhaps.
Fourth, they will hopefully serve as a “discovery mechanism” for further related reading.
Fifth and finally, they will hopefully serve as an index for you to return to at a future point in time, to identify sections of the book worth rereading to help you better address current challenges and opportunities in your life – or to reinterpret and reimagine elements of the book in a light you didn’t see previously because you weren’t familiar with all the other models or books discussed in the third use case.
Page xiv: On zero-sum games:What is bad for the tumor is not necessarily good for me. - the late Amos Tversky Click To Tweet
Page xv: Tversky apparently had a good sense of humor and was a good storyteller… if he were still alive, undoubtedly Thinking Fast and Slow wouldn’t be so horribly written ( TFS review), and perhaps more Misbehaving-like.
Page xvi: Kahneman once pronounced (in an interview, no less) Thaler’s laziness to be his greatest asset, because it means Thaler only works on problems he finds interesting.
You gotta love him already. Three cheers to not having grit. There’s actually a dose-dependencyangle here: being too willing to do things you don’t want to do often means you get sucked up into, well, doing stuff you don’t want to do.
Page 4: Thaler begins the book by introducing the concept of introducing “supposedly irrelevant factors”: quirks of our cognition that demonstrably prove that we are, in Thaler’s terms, humansrather than econs. What is an econ and how does one compare to a human, you ask? I think the best explanation is actually from Sunstein/Thaler’s Nudge ( Ndge review + notes) on pages 6-7:
But the folks that we know aren’t like that. Real people have trouble with long division if they don’t have a calculator, sometimes forget their spouse’s birthday, and have a hangover on New Year’s Day.
They are not homo economicus; they are homo sapiens.”
Thaler’s students preferred, somewhat absurdly, getting a nominal score of 96 out of 137 (70%) rather than 72 out of 100 (72%).
So, since making his students happier without changing their grades in any meaningful way was a “free lunch,” Thaler decided he liked being popular and started making his exams out of 137 points instead of 100.
Astute readers may have put two and two together by now: yes, I more or less stole PAA’s book-rating scale from Richard Thaler.
It is not coincidental that 7/5 = 140, or close enough to Thaler’s 137.
The decision was inspired by two factors: first, the realization that a standard 5-point review scale didn’t provide enough room for nuance between “mediocre” and “great” books without resorting to decimal points that somehow were unaesthetic…
and second, from reading Misbehaving, I realized that I would make readers (and, potentially, authors!) happier if I rated their favorites 5/7 rather than 3.5 / 5, even though the ratings are algebraically equivalent.
(Note: my ratings don’t actually map to some sort of percentage scale; vaguely, 7/7s would be A+ perfect scores, 6/7s would be As, 5/7s would be Bs, 4/7s would be Cs, and the rest would be various failing grades. But still, it’s nominal grade inflation.)
Page 5: Thaler brings up the model of constrained optimization and also equilibrium as the fundamental principles of economics. Classical economic theory assumes that people rationally optimize for their utility without any biases…
Classical economic theory, as we will see, is blatantly wrong.
Page 6: What makes it wrong? Thaler notes (as in Nudge) that, first of all, many problems are complex, and we’re not omniscient. Choosing jam at the grocery store is always overwhelming for me (THERE ARE SO MANY Y’ALL), let alone trying to evaluate a mortgage.
Thaler also notes that factors like the divorce rate make it hard to justify the assumption that people make optimal choices. Again, a quote from Nudge (p 226) is relevant here, covering overconfidence, base rates, etc:
“Unrealistic optimism is at its most extreme in the context of marriage. In recent studies, for example, people have been shown to have an accurate sense of the likelihood that other people will get divorced (about 50 percent).
But recall the fact that they have an absurdly optimistic sense of the likelihood that they themselves will get divorced. It’s worth repeating the key finding: nearly 100 percent of people believe that they are certain or almost certain not to get divorced!
It is in these circumstances, and in part for that reason, that people are immensely reluctant to make prenuptial agreements[,] believing that divorce is unlikely, and fearing that such agreements will spoil the mood…”
He also foreshadows hot vs. cold emotional states and sunk costs here… we’ll get into it.
Pages 7 – 8: Ironically, the “econs” premise sort of allowed economics to become the most “scientific” of the social sciences thanks to math/physics envy. But it’s also what made it completely and horribly wrong: Thaler states, unequivocally, that it’s time to stop making excuses.
Thaler also states, fairly, that not all of classical economics is wrong, and we can reasonably well replace the “econs” assumption with more realistic assumptions, without tearing the whole thing down.
There are real-world consequences, since much government action is based on economic policy.
Page 9: So what’s behavioral economics? It’s economics:
“done with strong injections of good psychology and other social sciences.”
It is more correct (obviously), and as Thaler points out, it’s also
“more interesting and more fun […] the un-dismal science.”
Page 11: Thaler on Misbehaving:My only advice for reading this book is stop reading when it is no longer fun. To do otherwise, well, that would be just misbehaving. - Richard Thaler Click To Tweet
Page 13: Thaler discusses statistical vs. identified lives here: “econs” wouldn’t see a difference, but in the real world, the amount of money we’re willing to spend to rescue trapped miners we know about, vs. the amount of money we’re willing to spend to save a “statistical” life via mosquito nets or a new hospital or whatever, well, those are two different numbers…
This is salience bias and Thaler hits it hard throughout the book.
It shows up all over the place: for example, David Oshinsky’s medical history “ Bellevue” ( BV review + notes) has a fascinating section overviewing how American doctors failed to take germ theory seriously until President Garfield died – not of the assassin’s bullet, but rather from septicemia introduced by his doctors’ dirty fingers. The death of a President did for Germ Theory what statistics and science could not.
Pages 17 – 18: Thaler with a succinct explanation of opportunity costs, which we neglect because, again, they’re not salient. The net effect of this is the endowment effect (one of the core pieces of research in the book): we value things we already have more than things (of equivalent value) that we don’t have.Dumb Stuff People Do is |unfortunately| not a satisfactory title for an academic paper. - Richard Thaler Click To Tweet
Pages 22 – 23: Thaler brings up hindsight bias, which he does a really good job with later with the CEO and 23 executives and the “dumb principal” problem.
Thaler encounters Kahneman/Tversky’s idea that heuristics and biases, like the availabilityheuristic, cause people to make predictable errors. The intellectual precursor was Herbert Simon’s “bounded rationality.”
Pages 25 – 27: Thaler establishes the difference between “normative” and “descriptive” theories; the former say what people should do; the latter say what people actually do. Classical economics is actually pretty good as a normative theory – we should think like economists, most of the time! – but it sucks at describing what people actually do.
Thaler proves we’re not intuitively good at the Pythagorean formula.
Page 28: marginal utility in one graph. Also known as “why I’m capping ACM at $50MM FPAUM.” This is an astonishingly powerful but entirely un-understood concept.
Page 29: Thaler notes that classical expected utility theory is:
“the right way to make decisions.”
Except we don’t actually do that. (We should, though.)
Pages 30B – 31: Thaler comes back to contrast bias:When we have adapted to our environment, we tend to ignore it. - Richard Thaler Click To Tweet
The key takeaway is that if we’re modeling people’s utility and the way they make decisions, we need to do it not based on absolute levels, but rather based on the delta/change from that level.
Here is my rough dumb explanation for why contrast bias exists: it’s probably energetically efficient. It’s well known that cognition is expensive – see Ackerman’s “The Genius of Birds” (Bird review + notes), the aforementioned “The Violinist’s Thumb” – or Charles Duhigg’s “The Power of Habit” (PoH review + notes).
So, we develop energy-saving cognitive biases, like contrast bias. Just like in a video, how you only have to update the pixels that change, it’s probably energetically efficient to not be on high alert all the time, but note differences, because differences represent threats (predators) or opportunities (prey) that we may not have evaluated yet.
The “hedonic adaptation” phenomenon is explored best in Shawn Achor’s “ he Happiness Advantage” (THA review + notes) – our tendency to adapt to our circumstances means that we can’t just keep pushing happiness over the cognitive horizon by saying “I’ll be happy when X,” where X is – graduate college, get job, have kids, retire, etc.
Pages 32 – 33: Thaler cites the “Weber-Fechner Law” of “just noticeable differences,” which play into contrast bias: we notice an ounce when it comes to two vs. three ounces of cashews (Thaler WILL notice if you steal his cashews), but not when it comes to the weight of a backpack filled with 40 lbs of camping gear.
This is also why our headlights seem to go out at the same time, or why my mom will drive across town to save a few bucks on a couple pounds of apples…
Page 34: Thaler talks about loss aversion – the phenomenon wherein losses cause twice as much pain as equivalent gains cause pleasure.Loss aversion is the single most powerful tool in the behavioral economist’s arsenal. - Richard Thaler Click To Tweet
There are a lot of
Page 37!: Yeah, here’s why I love Thaler. On product vs. packaging:
“Few [academics] enjoy the writing, and it shows. To call academic writing dull is giving it too much credit. Yet to many, dull writing is a badge of honor.
To write with flair signals that you don’t take your work seriously and readers shouldn’t either.”
Breaking the fourth wall, Deadpool style… Thaler, of course, is the anti-academic, in more ways than one. His writing is phenomenal.
Page 43!: In the first example of economists being humans rather than econs, Thaler notes that a lot of economists faced status quo bias, commitment bias, and simple incentives / local vs. global optimization problems. One unusually candid economist literally asked Thaler: if your newfangled theory is correct, what do I do? I’ve spent my entire career figuring out how to do it the old way…
Pages 44 – 45: This was a phenomenal “exposing ideas to reality” bit that is reminiscent of various parts of Superforecasting by Tetlock ( SF review + notes) as well as How Doctors Think by Groopman ( HDT review + notes– see , specifically the bit about cardiologist James Lock).
Thaler discusses how firms were long assumed by economists to be profit-maximizing, because that’s, of course, what they should be doing (economics as a normative theory) – but does it work as a descriptive theory?
Thaler notes that Richard Lester of Princeton had the “temerity” to actually, you know, ask business managers how they ran their companies, and it turned out that it wasn’t the profit-maximizing, marginal- utility approach…
Page 47: Thaler on humans vs. econs:
“We don’t play chess like a grandmaster, invest like Warren Buffett, or cook like an Iron Chef. Not even “as if.” It’s more likely that we cook like Warren Buffett (who loves to eat at Dairy Queen.)”
Pages 48 – 49: incentives, which we all know are important. Thaler comes back to these; the key here is that they are not a magic invisible hand-wave that makes everyone figure everything out – again, because we’re humans, not econs. If people have a cognitive bias at play, offering them money doesn’t magically make it go away.
Thaler notes that we don’t actually have “well-defined preferences” – sometimes we will state, if given the opportunity, that we BOTH prefer Coke to Dr. Pepper and Dr. Pepper to Coke – and economists “cannot tolerate” that. That “will not do.” It upsets one of the bottom-of-the-pile jenga blocks upon which classical economics is built.
Pages 50 – 51: How does learning affect decisionmaking? Thaler notes (as does Don Norman, and many others) that learning requires frequent practice and immediate feedback.
But in the real world, people don’t always learn from experience, even in situations they get to repeat all the time (like grocery shopping). It’s difficult to argue people have any opportunity to “learn” how to choose a marriage partner, or save for retirement.
(See “ Nudge” for examples of how feedback can be unclear in many economic situations, especially given short-term benefits and long-term costs interacting with hyperbolic discounting, as we’ll get to here later.)
Page 51!: I wish Amos Tversky was still around… Tversky asked an economist about the decision-making capabilities of the economist’s wife. As he got more and more inebriated, he told more and more fun stories.
“you seem to think that virtually everyone you know is incapable of correctly making even the simplest of economic decisions, but then you assume that all the agents in your models are geniuses. What gives?”
Economists, here, according to Thaler, often do the “invisible handwave” and blubber about market forces. Or something.
Page 52: Thaler here notes that incentives don’t solve the problem because people who aren’t sophisticated enough to know what they’re doing can often be taken advantage of by high-paid experts with their own incentives. Nudge goes into a lot more detail here on, for example, student loans and mortgage brokers.
Page 57: Thaler once again emphasizes that expected utility is the correct, “normative” way to think about opportunity costs: if you could sell something for $X, it’s irrelevant how much you paid for it. The opportunity cost of using/consuming the thing is $X. (Note that Thaler isn’t anti-making-memories; see the ensuing bit about transactional utility.)
Pages 59 – 63: Thaler eventually decided that standard utility theory only explained “acquisitionutility” – the surplus between utility and price paid. Consumers also have “transaction utility” – the quality of the “deal” relative to the “reference price.” This is an example of contrast bias but also product vs. packaging.
The interesting experiment here is that people’s enjoyment of a cold beverage on a beach, given a certain price, is dependent upon where they were told the beer was bought, and what they think it should have sold for at the type of establishment (bodega vs. fancy hotel).
Thaler notes that transaction utility causes us to buy things we don’t need as consumers and, on the flipside, can “prevent our consuming special experiences that will provide a lifetime of happy memories.” On the other hand, for retailers, doing away with transaction utility is a massively bad business strategy… as J.C. Penney found out.
As we’ll see later in the interlude about the ski resort, you can actually give your customers more transaction utility without necessarily giving them more acquisition utility. This is also why stores end prices in $.99…
Page 65: Thaler is crowned the first (and probably only) “clinical economist” by saving a young mother from arguments with her school-aged daughter over wearing dresses that had already been bought. Sunk costs.
(Thaler, as he will admit on an occasion or three, is only human, and tried to pull the same sunk cost argument on his own daughter when she wasn’t using some prepaid ski tickets. As the daughter of an economist, she was way too smart for that.)
Again, Thaler emphasizes that paying attention to sunk costs is stupid, and we shouldn’t do it… but we do.
Page 67: That said, sunk costs evaporate eventually, with either time or “getting our money’s worth.” This is likely due to recency bias – a function of our memory – see Daniel Schacter’s “The Seven Sins of Memory” (7SOM review + notes). As Schacter notes toward the end of the book,
“A system that renders information less accessible over time is therefore highly functional, because when information has not been used for longer and longer periods of time, it becomes less and less likely that it will be needed in the future.
On balance, the system would be better of setting aside such information… [our memory… makes a bet that when we haven’t used information recently, we probably won’t need it in the future.
We win the bet more often than we lose it, but we are acutely aware of the losses… and never aware of the wins.”
While the idea of a photographic memory is often romanticized in film or fiction, Schacter notes when recounting an anecdote about a famous Russian mnemonist –
“he was unable to function at an abstract level because he was inundated with unimportant details of his experiences.”
Schacter also references how the same neurological mechanisms that enable autistic children and adults to have amazing memories can prevent them from effectively generalizing.
Pages 68 – 69: So here’s the hilarious wine experiment, when what was supposed to be a joke answer – i.e., that a positive opportunity cost was actually an economic savings – actually got a significant number of responses.
At the bottom of the page, Thaler notes that a surprising number of readers responded to the lottery… I found the same thing with my gift card incentive for book recommendations, which overwhelmed me with so many replies that I still haven’t gotten through all the books!
Page 71: Humans’ ability to evalute sunk costs is so bad that Thaler notes, wryly, in the title of a paper, that many people: “Invest Now, Drink Later, Spend Never.”
The business takeaway is that if you can transform “spending” into an “investment,” people like it more.
Page 72: The same goes for Costco memberships, or Amazon Prime. Thaler later references the phenomenon in relation to car purchases; the costs of owning a car are not as salient as the costs of taking a taxi, because we don’t mentally depreciate the car’s purchase price every time we turn the key…
Thaler notes the famous “kill your darlings” writing advice, and has a quasi-Twain-letter-like solution: keep the cut material around in another folder and plan to do something with it later.
Oh, and Thaler ignores opportunity costs when drinking old wine he’s already bought. Just so you know 🙂
Page 74: Mental accounting gets a more thorough treatment here than in Nudge ( Ndge review + notes); fungibility is a useful/important concept that a lot of people don’t actively think about: money spends just as well no matter where it comes from.
(Thaler elsewhere references the principal/interest issue as it relates to dividends; similarly, I have a hard time convincing my educated and intelligent mother that earning money via intelligent investing is economically equivalent to having a job – the money spends the same…)
Page 76: The takeaway from “mental accounting” is that it results in disproportionate local vs. global optimization – if we have an unexpected windfall (or expense) in one mental “bucket,” we’ll make very curious, non-utility-maximizing decisions to compensate for that. For example, spending more on premium gas rather than pocketing the money when gas prices drop.
Page 77: Thaler notes poor understanding of fungibility means people often have savings accounts at low interest rates while also having credit card debt at substantially higher rates (hint: don’t do that.) He also provides an interesting discussion of the interaction of social proof with home equity, and how it shifted over time.
Page 81: People aren’t naturally attuned to probabilistic thinking; also, the “house money” effect is real. People are drawn to lottery tickets. (This can be seen even in the stock market). The reverse is also true… people start making riskier bets to “get back to even.”
Page 84: Here, Thaler notes that there’s some evidence on this behavior even among professional mutual fund portfolio managers.
Page 86: Thaler’s cashews is the best story ever, basically.
Page 87: In an amusing example of “telephone,” it turns out that Adam Smith’s “invisible hand” was mentioned only once in passing but became the most famous part over time; conversely, some of his other ideas have been forgotten, including some precursors to behavioral econ.
Page 92!: “dynamically inconsistent” judgments of our utility: that is to say, what we want right now may not be what we want in the future.
I will offer a very small caveat, which is that in some circumstances, I think it’s actually not irrational to be present-biased, especially when there may be some nonlinearity in the future (a major health event, or your kids leaving for college, or whatever.)
This, directionally, though not literally. (I eat tons of vegetables and very little red meat, and certainly no alcohol or cigarettes.)
Page 94: Again in an example of path-dependency and social proof and incentives and status quo bias and local vs. global optimization and should we go on? Nah, that’s enough: economists magically adopted the “econ” model, and then econs just kept getting smarter and smarter to ridiculous degrees…
Page 96: … to the point where humans, known for not being able to delay gratification very well, are now (per Robert Barro) modeled as econs who think not only about the long-term impact of a windfall on their children’s inheritance and grandchildren’s inheritance, but also the offsets of the deficit impacts of a tax cut and so on…
Page 97: Psychologists, naturally, thought economists were !@#$ing nuts. (To be specific, presumably they thought economists were cashews.)
Page 98: Thaler, slightly less elegantly than in Nudge:We clearly need to get back to studying Humans rather than Econs. Humans do not have the brains of Einstein, nor do they have the self-control of an ascetic Buddhist monk. - Richard Thaler Click To Tweet
Page 99: Thaler notes that graduate students
“rarely read anything written more than thirty years ago.”
Kind of interesting. Recency bias but not quite. Also one to many.
Pages 100 – 101: The marshmallow experiments! Thaler notes the standard conclusions (i.e. that the ability to delay gratification is valuable). He also notes the videos are hilarious.
I recently learned via Jennifer Ackerman’s “ The Genius of Birds” ( Bird review + notes) that cockatoos have been subjected to the marshmallow experiment and, seemingly, outperformed some human children.
Thaler would be delighted to know that cockatoos will wait, like, 80 seconds to get a cashew rather than a pecan.
If I ever get a cockatoo, I’m naming him Thaler and giving Thaler-the-cockatoo cashews as treats.
Page 102: Some research suggests that even animals discount hyperbolically, suggesting a trait adaptivity basis (unsurprising).
Pages 103 – 105, 109: Thaler’s “ Planner-Doer” framework is super interesting, but it (sadly) does not appear to have been adopted by behavioral economists at large. So I will do my very best, as a one-man army, to spread its glory far and wide.
This is a phenomenal little conception in which Thaler, basically, adapts the principal-agent problem (a subset of local vs. global optimization) into a two-track view of the human mind: one altruistic “planner” trying to maximize the total utility of a series of “doers” who care only about the present.
My own conception of this is, similarly, that we experience life as a series of moments, and so we essentially have a hot-cold empathy gap with relation to ourselves: it’s hard for us to step outside our current schema and have empathy towards our future selves.
It is tremendously useful because the practical output (particularly if you believe in willpowerdepletion, on which I know there is some controversy) is that it completely undermines and destroys the “ grit” approach to the world. It’s a losing battle. Much better, if you literally conceive of your future self as someone who needs protection from the (cumulative) actions of your current selves, is structural problem solving, specifically utilizing forcing functions, activation energy, habit, and so on.
Thaler notes you can vaguely map the “planner” to System 2 and the “doer” to System 1, but I don’t think you need to.
Pages 116 – 120: “ Misbehaving in the Real World” is a great chapter title, and also a great story. How would Richard Thaler utilize behavioral economics to improve an actual business?
Combining salience, transactional utility ( contrast bias), fairness, sunk costs, utility, product vs packaging, and a few other models, here’s how he helped a ski resort improve its economics. First, he looked for ways to improve the perceived utility surplus of consumers while either maintaining or even improving the mountain’s cut. Some of the major ways included:
– Eliminating a small fee ($1) for a special racecourse that skiers enjoyed; it didn’t generate much revenue and was a pain to pay since you had to dig through layers of clothing.
– Having ski instructors offer free tips during their downtime.
– Creating additional “transaction utility” by offering “ten packs” of tickets (in advance) for the price of six full tickets – this helped to bring in cash notwithstanding how much or little it snowed (reducing risk in the business). Few people actually skied 10x/year, so the resort didn’t even really give up much in the way of economics (and although Thaler didn’t specify, variable costs were probably pretty low even if people did come).
– Going back to the wine story, this made the ten-pack a “ sunk cost” and people now viewed skiing as “free,” and sometimes brought friends (similar to the Six Flags model).
– Finally, offering to let people use unused passes from the previous year if they bought another “ten-pack” this year… not likely to provide any actual utility (if you went skiing 3x last year, you’re probably not going to go >10x this year!) but helped boost the perception of “ fairness” (which is one of the things they were focused on, since it wouldn’t seem “fair” to charge more than other big ski resorts).
Thaler’s discussion here is really solid and should be read a few times for maximum learning.
Pages 121 – 122: Switching to car sales, another example of how framing and contrast bias create the “just noticeable difference” – if you mark a $14.8K car down to $14.5K, nobody cares; if you separate it out and call it a $300 “rebate,” it sounds really nice – even though you have to pay taxes on it!
Pages 123B – 124: Despite Thaler providing GM with some good ideas, they didn’t really want to go for them… cough, status quo bias, cough.I have learned over the years... the reluctance to experiment, test, evaluate and learn... is all too common. I have continued to see this tendency, in business and government. - Richard Thaler Click To Tweet
“we [humans] are seldom motivated to seek self-renewal when we’re successful… when the fans are cheering, why change a winning formula? … because the world is changing…
even when life seems perfect, you have to take risks and jump to the next level, or you’ll start spiraling downhill into complacency without even realizing it.”
Thaler views this as an example of endowment effect: people believe it’s fair for the (usually salient) “normal terms of trade” to always be available; when those terms are taken away (via a price increase), loss aversion kicks in, maybe even to the point of deprival superreaction syndrome(Munger’s concept, not Thaler’s).
Thaler actually touches on this last bit in the context of wages: why, in recessions, do employers not just cut everyone’s wages evenly rather than laying off some people and keeping others? Because “cutting wages make workers […] angry” whereas when workers are cut, they are “not around to complain.”
Fascinating. Thaler goes on to discuss Uber and other examples of tone-deaf pricing that may be rational but are perceived as unfair. See Brad Stone’s “ The Upstarts” ( TUS review + notes) for more on Uber.
Thaler also mentioned Home Depot helping out during Katrina. I seem to recall an earlier example of this being cited in Built From Scratch but I read it a long time ago and can’t remember. Ironically, b-school training might make people even more tone-deaf to fairness.
Page 139: The bit about Next (the other Grant Achatz restaurant, somewhat less well-known than Alinea) is interesting. (Here’s the blog post.) Thaler notes the NFL tries to do the same.
Thaler begins to move into the flip side of fairness: are we “fair” to others even when it’s not in our own interest? (The answer is not entirely, but somewhat directionally, yes.)
Pages 145 – 147: People don’t like to be suckers, but if you take them out of the situation and put them in a new one where they won’t be taken advantage of, they revert.
Thaler cites farm stands as a good example: most people will be honest and pay for what they take, but you want your money in a lockbox so someone doesn’t steal it. I would, for what it’s worth, cross-reference to Scale here; I think this works better in rural communities than in cities because of the “anonymity” angle…
Here, Thaler uses status quo bias as an explanation for why people don’t move to find jobs, but I don’t think that’s really what’s going on. To me, “ status quo bias” represents going with the default or with what’s worked; I think setting down roots in a community is completely different: there are direct transactional costs to moving, and there’s also a lot of utility lost if you have deep ties to the community built over years or decades that you probably couldn’t replicate everywhere.
Page 160: The next 40 pages are super and hard-hitting; a bit like the first 100 pages of Nudge. Here, Thaler points out (again) how framing and loss aversion can cause us to evaluate arithmetically-equivalent options differently. The takeaway? If you want people to do something, present it in a the most favorable way (i.e., “a 33% chance of success”) rather than a negative light (i.e., “a 67% chance of failure.”) Do note people respond more to loss; i.e. “if you don’t take this pill, you’re more likely to die” is more effective than “if you do take this pill, you’re more likely to live.” See p. 159 of “ Nudge” ( NDGE review + notes).
Additionally, people tend to gamble to avoid sure losses – i.e. they’re willing to take a bigger loss to get a chance at not having any loss at all – but they tend not to gamble when presented with sure gains.
Another money quote on fairness:
Economists thought that fairness was a silly concept mostly used by children who don’t get their way.
Page 162: Thaler realized his best strategy at a conference when presenting “disruptive” material was to use humor.If people are laughing, they tend to be more forgiving. - Richard Thaler Click To Tweet
Page 165: Thaler here analyzes the (totally irrational) preference for dividends, which for a variety of reasons is usually bad.
Page 169: Thaler references Kuhn’s The Structure of Scientific Revolutions ( Kuhn review + notes), which is pretty dense but may be interesting to some readers. (I think Peter Godfrey-Smith’s Theory and Reality is somewhat more complete, though certainly neither are high priorities.)
Page 172: The A B 2 3 card question demonstrates confirmation bias.
Page 177: Thaler: “Danny [Kahneman], who prides himself on being a pessimist…” And this is why Thinking Fast and Slow sucks.
Pages 179 – 180: Thaler with an interesting insight on why (in his experience) interdisciplinary efforts often fail:
“academics don’t like to talk about research in the abstract […] but if scientists from one field start presenting their research findings in the manner that the colleagues in their field expect, the scientists from other disciplines are soon overwhelmed by technical details they do not understand, or bored by theoretical exercises they find pointless.”
Kind of interesting to think about the mental models here. This was actually one of the more interesting angles in Kuhn’s The Structure of Scientific Revolutions, which does a surprisingly good job of explaining many of the phenomena observed by Thaler (and others) as they tried to create a new paradigm in economics. Kuhn talked about specialization and scientists’:
“attempt to force nature into the preformed and relatively inflexible box that the paradigm supplies.”
Local vs. global optimization + man with a hammer – scientists in each field are more focused on doing things their own way, in language and technique they understand and are good at communicating, rather than focusing on the big picture. In some sense, rather than focusing on what would be useful, they’re focused on “looking where the light is…” i.e. what they’re good at studying/measuring.
This last point is driven home by Thaler on the next page:
“Finally, for some reason[,] the study of “applied” problems in psychology has traditionally been considered a low-status activity.”
Page 182: Circling back to explain the “conditional cooperator” effect observed in the Ultimatum/Dictator games earlier, Thaler cites Matthew Rabin, who finds evidence for – wait for it – the reciprocity bias discussed (among other places) in Cialdini’s work.
Pages 186 – 187: Thaler touches on the planning fallacy as well as base rates and the inside/ outside view here. The explanation is succinct and useful; see Mauboussin, Tetlock, etc for more on this, particularly pages 117 – 119 of Superforecasting ( SF review + notes).
Pages 188 – 190!: These pages right here are money – some of the most important/applied in the book, in my opinion.
Thaler puts a new spin on the classic “principal-agent” local vs. global optimization model by inventing a new term: the “dumb principal” problem. In the classic principal-agent theory of the economics literature, Thaler notes, executives in organizations:
“are said to make poor decisions because they are maximizing their own welfare rather than that of the organization. Although this description is often apt, in many cases the real culprit is the boss, not the worker.”
Why? Thaler incorporates a number of factors, including expected value, hindsight bias, loss aversion, luck, memory, and incentives, to explain what happens. In most organizations, executives should (Thaler argues) be compensated on the basis of making ex-ante good decisions with a positive expected value.
The problem is that after the fact, if it pays off, the boss may, thanks to hindsight bias / flawedmemory, believe it was a bad decision all along (because it didn’t work)… and therefore punish the executive who made the decision.
Thaler argues a more effective way would be to broaden the problem framing and evaluate managers’ performance in a broader context: if you set up an incentives structure where people are disproportionately punished for losses in the context of their individual budget, but only moderately rewarded for equal gains (i.e. institutionalized loss aversion), then you’re going to get a bunch of risk-averse managers.
This is exactly what happened with a large company that Thaler was working with: when presented with the potential for each of his 23 executives to make a meaningfully positive +EV bet, the CEO obviously would have wanted all 23 bets to be made – but only three of the 23 executives would actually have made the bet, even theoretically, let alone in practice!
One of the managers, in fact, highlights the loss aversion hypothesis I present above – the manager noted that if the bet worked, he might get a bonus equivalent to a few months’ work… if the bet didn’t work, he thought there was a good shot at him being fired.
Clearly the personal marginal utility of making the bet on an expected-value basis is meaningfully negative, despite the marginal utility for the firm being meaningfully positive… hence the local vs. global optimization problem.
Thaler’s big-picture argument here is behavioral in how it gets to its end, but (as he points out later) not in conflict with most/many traditional economics concepts. There is a nuance, though. In Thaler’s worldview, it’s actually not the manager’s problem: it’s the principal’s problem. The manager isn’t being stupid and human; even an “Econ” placed in that incentive system would make the same decision.
So it’s not a case of managers doing something selfish that helps them but hurts the firm (like, say, not cooperating with a manager from another department so that they won’t be outshone – i.e. contrast bias). It’s, in this case, a “dumb principal” problem.
“So often the problem is in the system, not in the people. If you put good people in bad systems, you get bad results.”
Also see pages 162 – 167 of Don Norman’s The Design of Everyday Thingswhere he delivers his phenomenal credo on “human error” vs. “design error.” In the context of a business, this is a design error rather than a human error.
Page 192: Circling back to dividends, mental accounting, and loss aversion – as well as few other pieces here ( hyperbolic discounting probably also applies) – Thaler cites research by Mehra/Prescott that finds that the equity risk premium basically shouldn’t exist.
This makes sense; obviously, over any long-enough time horizon, you’re very likely to earn a substantial premium by investing in equities rather than debt with the ERP as big as it is…
… and yet in the real world, you end up with some pretty nonsensical situations. For example, to actually argue in favor of dividends here for a minute, when I started my investing career, there were a number of large, relatively “safe” companies that were issuing debt at far lower interest rates than the dividend yield on their stock; the dividend payout ratios were sufficiently low such that even alarmingly bad business conditions would not endanger the dividend. In fact, dividends were highly likely to grow over time.
The question, in my mind, was who would buy reasonably long-term bonds at such low rates of return when any rational analysis would suggest that over a reasonable holding period, it would be very unlikely that you would earn a lower return from the stock than the bond, and almost guaranteed that your “income” over the period would be higher (with a slightly elevated but not that big risk that at the end of the period, you wouldn’t be able to redeem your investment for what you paid.)
Page 195: Here again is one of the areas where I disagree with Thaler; it may be irrational to turn down one bet when you wouldn’t turn down 100, but I think it’s very sensible to do so.
I simply don’t want to lose $100 on a bet because there’s no guarantee that I’ll find someone else offering me similar odds in the future.
In the stock market, on the other hand, there pretty much is that guarantee…
Page 197!: Here is another one of the key insights: one paper demonstrates the (real-world) phenomenon wherein the more often you check your portfolio, and thus see losses and trigger loss aversion, the more likely you are to make bad decisions…
Page 198: Thaler’s advice for better returns? Stop reading (or watching) the news. This is something I do myself, although it was actually something I’d started doing well prior to reading Misbehaving, thanks to encountering Shawn Achor’s work.
(For more of Thaler’s advice for better investing returns, see Nudge.)
Pages 200 – 201: In another example of theory vs. reality a la the earlier discussion of one researcher having the temerity to ask executives how they made decisions, Thaler and some collaborators set out to determine how cabbies actually respond to higher/lower-wage days.
Astonishingly, the opposite of classical economics holds true: some cabbies (particularly newer ones) tended to work on any given day until they’d made a targeted amount of money, then quit, paradoxically leading to working more hours on low wage-per-hour days and fewer hours on higher-wage-per-hour days.
More experienced drivers tended to not do this, but Thaler points out there are, of course, behavioral factors at play here: justification to a spouse, as well as an external self-control measure… sort of the same (my analogy) as a calorie counter on an elliptical.
Page 206: Thaler starts to get into dismantling the efficient market hypothesis here; he notes dryly that one component of the efficient market hypothesis – the “price is right” component – can’t be directly tested. Convenient…
Page 213: The pranksters!
Page 217: Thaler notes that the high rate of market turnover is extremely difficult to explain under the EMH, but easy to explain behaviorally.
Study subjects who are provided information about a fictional student’s sense of humor make just as confident guesses on GPA as they do when provided with the decile of GPA.
Page 221: You have to laugh at the absurdity here:
“It was not so much that anyone had refuted Graham’s claim that value investing worked; it was more that the efficient market theory of the 1970s said that value investing couldn’t work. But it did.”
That is not scientific thinking. Oops. How did economists respond? Like humans with endowment effect and sunk costs and man-with-a-hammer syndrome: rather than admit that their obviously-wrong theory was, you know, obviously-wrong, they bent over doing contortions with “factors” to explain how stock prices really were efficient.
Page 229: It is difficult to understate the level of moronicness required to defend the EMH at this point. Thaler (who gets along with Fama notwithstanding their differences) puts it a little less bluntly than I do: commenting on the “five-factor” Fama-French model, he notes:
“it is difficult to tell a plausible story in which highly profitable firms are riskier than firms losing money.”
Yet believing in the EMH, on the basis of current research, would require believing that somehow, investing in more profitable firms is riskier (remember, valuation is already a factor, so that’s adjusted out!) Again on overconfidence, scientific thinking, etc.
Page 235: One of my other small quibbles with Thaler: here, he references the Shiller P/E, which is a profoundly nonsensical metric that I view as completely worthless. He’s not really a finance guy, so that’s okay; it annoys me more when investors who should know better think that the CAPE is something other than complete bullshit.
Page 243: An example of Misbehaving being a twofer: almost as interesting (and sometimes more interesting) than Thaler’s anomalies and SIFs is the story of how classical economists dug their heads in the sand, and how Thaler and friends called attention to what they were doing. Salience.
Here (and a few other places), Thaler talks about a quasi-stunt-marketing approach a la Wal-Mart and Salesforce’s early days: by inviting controversy and going back-and-forth with big names like Merton Miller, Thaler + friends were taking advantage of contrast bias and authority bias.
Think about Sam Walton’s antics in the early days of Wal-Mart (think panty sales and donkey rides), and Salesforce’s famous tactics for stealing the limelight from Siebel.
Pages 246 – 247: Thaler goes into some depth on the Palm/3Com violation, which destroys the EMH.
Unfortunately, its adherents were too biased and steeped in ideology to remember that if you’re going to try to be scientific and have physics envy, you also have to acknowledge that while a theory can never be proven, it can be disproven with merely one counterexample.
One of the most interesting subthreads in Misbehaving, every time I read it, is how economists failed to act like econs, and in fact acted wildly irrationally when confronted with clear evidence of the psychological realities of the world.
Pages 249 – 250: Thaler discusses the LTCM debacle, and notes that he viewed examples like Palm-3Com as the tip of an iceberg, whereas Eugene Fama viewed it as all there was. (Thaler, incidentally, has a market-beating mutual fund based on application of behavioral biases.)
Page 259: more stunt marketing… cross-reference Marc Benioff’s “ Behind the Cloud” ( BtC review + notes) here. Interesting parallels between Thaler going after big-name economists and Salesforce going after Siebel…
Page 261: … the anecdote about Thaler bringing respected jurist Posner to, basically, shouting/tears, is truly pretty funny/sad/illuminative of some of the things I’ve been talking about here – ideology-driven irrationality, etc.
Page 262: As with Adam Smith being misinterpreted, Thaler notes that the widely-used Coase theorem assumes transaction costs are small. Not only is this not the case in the real world, but thanks to loss aversion / endowment effect, it doesn’t even exist.
Page 265: Again, the meta-story here: Thaler notes the historical tendency of the University of Chicago (which appears to have been corrected) to encourage an ideological echo chamber.
Page 266: another example of absurd ideology-driven irrationality. Also, Thaler’s response is killer.
Pages 271 – 275: “corybantic” is something I could’ve spelled but I would not have known what it meant. More pertinently, I find it amusing that the University of Chicago supports trading in organs, but not offices… and that offices in the real world are different from offices on a spreadsheet… and that even tenured faculty can be humans rather than econs.
Pages 277B – 278T: One defense of classical economics was the “Becker conjecture” – the idea that even if “most people” were irrational, it doesn’t matter because the people who make decisions are a rational elite (in fewer words).
Pages 279B – 280: A really nice summary here of some of the behavioral factors affecting the NFL draft, including the standard overconfidence/etc, but also including hyperbolic discounting, the winner’s curse, and – most intriguingly to me – what Thaler calls “the false consensus effect,” which is really just the schema bottleneck wherein you think everyone else shares your schema. See also Tetlock on poker in “ Superforecasting” ( SF review + notes).
Page 296B: I thought the “Matthew effect” / “Stigler’s Law” bit was interesting, and certainly true.
Pages 298 – 300: Thaler here on the way path-dependency turns into a behavioral bias: people become risk-seeking when they’re playing with house money, or really behind.
Pages 303 – 305: Thaler notes contrast bias again here: stakes depend on the circumstances (which is why we might be upset about losing a $20 bill from our wallet but unfazed by losing $2,000 in a retirement account.)
He also notes that people “are more willing to lie by omission than commission” and provides some
evidence of commitment bias – contestants in a gameshow who promised to split are 30 percentage points more likely to split.
And then he mentions the famous Nick/Ibrahim Golden Balls bit.
Page 315: status quo bias makes the default option really important; there is a huge difference between opt-in and opt-out enrollment. Thaler goes way deeper into this in Nudge ( Ndge review + notes), and it’s fantastic.
“Our premise was simple. Because people are Humans, not Econs, they make predictable errors. If we can anticipate those errors, we can devise policies that will reduce the error rate.”
“a breakthrough in finding our missing organizing principle [for Nudge.]”
Page 335: Thaler mentions Influence here and calls Cialdini the “most practical psychologist alive” (with Kahneman being called the “most important living psychologist.”)
“A 1 or 2% change in some outcome […] should not be a reason to scoff, especially if the intervention is essentially costless […] when the stakes are in billions of dollars, small percentage changes add up. As one United States senator famously remarked, ‘a billion here, a billion there, pretty soon you’re talking about real money.’”
Similar logic applies outside of public policy in the mental models arena: one of the allures of being an ideology-driven “hedgehog,” like the classical economists with their rational-actor or EMH, is that it’s awfully convenient from a cognitive-effort perspective to only have to think about one thing, and frame the world in terms of “those damn liberals” or “those damn Republicans.”
It’s also (literally) sexy; in Superforecasting ( SF review + notes), Tetlock discusses in a few places how nobody likes a many-handed forecaster. What plays well – both on TV and in the boardroom – is confidence, which is usually not correlated with “hedging.” Tetlock:
“people equate confidence and competence[…] one study noted, ‘people took such judgments as indications that the forecasters were either generally incompetent, ignorant of the facts in a given case, or lazy, unwilling to expend the effort required to gather information that would justify greater competence.’”
Mental models, in this context, are profoundly unsexy interventions. Although it could be argued that in some specific situation, knowledge of an important model might make you a million times more effective, not all models apply in all situations, so (generally) I think that it’s more directionally comparable to the small effect sizes Thaler mentions above: each model maybe makes you a little bit smarter… you’re not going to wake up tomorrow as Iron-Man.
… but the compounding effect is huge when multiplied by all the decisions made across your life.
Page 347: Thaler uses “Sigh.” as a complete sentence. Because behavioral econ has gone mainstream and he’s no longer a renegade.
Page 348: Econs, it is wise to remember, do not exist.
First Read: 2015
Last Read: 2018
Number of Times Read: 4
Planning to Read Again?: are you kidding??? At least another 10 times.
Review Date: spring 2018
Notes Date: spring 2018