In “Misbehaving: The Making of Behavioral Economics,” Richard Thaler follows the history of behavioral economics and his own career as one of its founding fathers and advocates, pushing back on classical economics.
Behavioral economics combines psychology and economics to better understand how humans make day-to-day choices and the internal biases that exist within us to make those decisions.
This lightweight book is for anyone trying to make sense of their decision-making and inner biases while walking through history in a linear narrative with short, digestible chapters. It contains significant insight into human behavior and people’s less than rational tendencies.
Thaler doesn’t take himself too seriously, which makes the book even more entertaining. While this book is great for people at any stage of their career, it can be especially helpful for young adults entering the workforce when the stakes are high and the mistakes aplenty.
A few ideas really stood out, starting with the recurring concept of the rational economy and the not-so-rational human.
Classical economics is based on the model that humans are rational beings, and when making decisions, they seek out what is most useful and profitable to them. Thaler argued that this is not the case for most humans and that economists should not assume that they behave like experts.
“A good rule to remember is that people who are threatened with big losses and have a chance of breaking even will be unusually willing to take risks, even if they are normally quite risk averse,” Thaler wrote. .
This way of behaving goes against the endowment effect – a classic theory that states that people tend to stick with what they have due to risk aversion – and shows that humans don’t always have a consistent way of being. Human behavior differs depending on the situation.
In the chapter titled “Value Theory,” Thaler discusses the value function, which was created by pioneering behavioral economics researchers Daniel Kahneman and Amos Tversky.
Unlike traditional economic models, it shows a loss function decreasing faster than the gain function increasing, or in Thaler’s words, “losses hurt twice as much as gains make you feel good”.
For readers to get the most out of the book, other concepts and anecdotes to pay special attention to include the principal-agent model, the cookie experiment, the efficient market hypothesis, Groucho Marx’s theorem, and the The effect of frequently checking your portfolio can have an impact on its composition.
Although this book was published in 2015, it will remain relevant for as long as humans exist and seek betterment. Decision making is an important skill, whether in the context of finance or not.
With the rise of artificial intelligence, social media, and digital accessibility to investment accounts via phones, humans should think about their decisions. It will be interesting to see what future researchers find regarding the impact of technology on our decision making and internal biases.