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Lesson 1: What Is Behavioral Economics?

Do you recognize this image?  If not, take a guess about where it could be from.

ECVP doesn’t offer too many clues.  The figures in the picture appear Greco-Roman, however, so maybe it was from an event in Southwestern Europe?  Or possibly an advertisement for a festival from 2005?

Any ideas?

Alright. While you were thinking, did you realize that the writing, figures and numbers in both sides of the image are the exact same color?

Not convinced?

I re-framed the ‘E’ from the original image to help to convince you that the details in both of the images are identical (If you’re still not convinced, you can do this yourself in Paint). Isn’t this example amazing? Go back to the original image and look at how distinct the two ‘E’s look. Yet they are, in fact, exactly the same.

As you can see from both examples, our perception of these details is extremely mutated by the way in which they were presented to us. The left image appears to have a black background with white details, while the right image appears to have a white background with black details. But this isn’t exactly the case.

Now try this exercise from one of my favorite books, Nudge.  Answer the questions as quickly as possible:

  1. A bat and a ball cost $1.1o in total. The bat costs $1.oo more than the ball. How much does the ball cost? ______ cents
  2. If it takes 5 machines 5 minutes to make 5 widgets, how long would it take 100 machines to make 100 widgets? ______ minutes
  3. In a lake, there is a patch of lily pads. Every day, the patch doubles in size. If it takes 48 days for the patch to cover the entire lake, how long would it take for the patch to cover half the lake? ______ days

What were your answers?

If you said 10 cents, 100 minutes and 24 days, congratulations, you are human. But those are not the correct answers. They are: 5 cents, 5 minutes and 47 days.

So What?

The point of these exercises is to show that as humans we can be very easily swayed, misled, and even negligent, all while being blissfully ignorant of these missteps.

In the image example, your perception depended on a seemingly arbitrary detail (the background). This concept, presenting the same object in different formats, is known as framing, and is one of the most well-known biases used by Behavioral Economists. For example, if I asked you to give my friend a ride, and told you nothing about him other than that he is a Reed College dropout, you might hesitate. But what if I had instead only mentioned that he is the founder of Apple? Then your reaction might be a little different. (Yep, that’s Steve Jobs!)

Or more commonly, think of a standard donation form.  They usually provide about four possibilities, and an open option, something like this:

[]$15  []$25  []$50  []$100  _____ Other

When presented with options in this way, most people tend to choose one of the middle two, not wanting to give too little, but also resisting to spend $100. But what if the options were instead changed to this:

[]$15  []$30  []$60  []$100  _____ Other

The total amount donated would most likely rise.

And Behavioral Economics Is…?

Behavioral Economics is a sub-genre of economics that borrows insight from psychology to further inform economic theory. The traditional, neo-classical subject in an economic model is assumed to: (1) be a rational decision-maker (2) have perfect information regarding their economic decision (3) be self-interested with stable preferences. But I think most anyone would agree, that as humans, our rationality can be somewhat limited. In a 2003 paper by Nobel laureate Daniel Kahneman, regarding his first encounter with the psychological assumptions made in an economics book:

Its first or second sentence states that the agent of economic theory is rational and selfish, and that his tastes do not change.  I found this list quite startling, because I had been professionally trained as a psychologist not to believe a word of it.

So this is exactly where the fledgling field of Behavioral Economics begins. Many in the field, including one of my favorites, Duke Professor Dan Ariely, frequently label humans as irrational decision-makers.  I, however, prefer the description of us as having “bounded rationality,” that is, we are actually quite limited by our lack of information, our cognitive ability, and our availability of time. We don’t continuously make bad decisions, rather we tend to stumble into the occasional trap or make a hasty, ill-advised choice.

But that is the caveat; our ability as humans to make split second decisions is overwhelmingly a positive, evolutionary one. And as is evidenced by Professor Ariely’s latest book, The Upside of Irrationality, Behavioral Economists are not only concerned with the negative.

But at this stage, the field is still an infant, and its boundaries are unclear and ever-expanding. Though the sharpest criticism regarding this sub-genre is that its insights tend to focus on individuals, and not markets or the broader allocation of resources, it has provided us with a profound amount of insight with respect to the quirkiness of human decision-making.

Why, for example, even though we fully intended to cancel the free trial once it expires, we fail to, and end up paying money. Or why, more generally, get-rich-quick schemes and faulty products continue to exist, even if they have been on the market for years. Or even how you can guilt people into recycling.

Pretty exciting stuff, if you ask me.

* The optical illusion was taken from ECVP (European Conference on Visual Perception, 2005)

The Mental Accounting Trick

Our second experiment exploited human failure in mental accounting.  That is, we noticed that there is a disparity in expected utility from purchasing an object among different percentage discounts, even if the nominal discounts are constant.  Confused? Read on!

The experiment was a simple survey, and consisted of 165 subjects answering 5 questions each.  The trick was that we didn’t care about the answers to four of the five questions.  And the only one that we cared about (the answer to question 4) actually had three versions.  We then divided the surveys so that 1/3 of those surveyed (55) received the first version of question 4, 1/3 received the second version, and the last 1/3 received the last version.   I will explain more, but in the meantime, the questions were:

1. If as a sophomore you are given the chance to live in Panther Hall on Upper Campus or Bruce Hall on Lower Campus, which would you choose?

2. The average student spends $250 on textbooks each semester.  Do you spend more, less or about the same?  From where do you usually buy your books?

3. Do you think having a meal plan saves or costs you money? (As opposed to grocery shopping only)  Does it encourage you to to eat better or worse?

4. If at the Campus Bookstore you find a $6 pen that you want, but find out that the same pen is on sale for $3 a few blocks away at the GotUsed Bookstore, what do you do?

5. Pitt is one of the most expensive public universities in the country (with respect to in-state tuition).  Which other schools did you consider?

The other two variations to question 4 were:

4. If at the Campus Bookstore you find a $30 novel that you want, but find out that the same novel is on sale for $27 a few blocks away at the GotUsed Bookstore, what do you do?

4. If at the Campus Bookstore you find a $150 textbook that you want, but find out that the same textbook is on sale for $147 a few blocks away at the GotUsed Bookstore, what do you do?

The only parts of question 4 that varied were the objects (pen, novel, textbook) and the price ($6, $30, $150).  The nominal discount, however, remained constant at $3 for each object.  The goal of the experiment, then, was to see if people responded to different percentage discounts, even if the nominal discounts were the same.  For example, in the pen question, $3 off is a 50% discount.  In the novel question however, $3 off is only a discount of 10%.

Again, we only cared about the results to question #4.  The purpose of the dummy questions were to prevent our subjects from knowing that they were participating in a psychological / economics-related experiment.  So, here were our results:

As Figure 1 shows, students were much more likely to accept the $3 discount when the total price of the object was lower.  46/55 accepted the discount for the $6 pen, 29/55 accepted the discount for the $30 novel, and 3/55 accepted the discount for the $150 textbook.  The irrationality in all of this, however, is that in each case students were offered the same nominal discount of $3!  Figure 2 demonstrates this well:

My prediction is that students valued those discounts in the exact way they are presented in Figure 2.  That is, they highly valued the $3 discount when it was an immense 50% of the price of the pen, yet they almost universally ignored it when it was a scant 2% of the textbook price.

Now of course, this doesn’t make much sense.  $3 is $3, regardless of what you do with it (obviously not accounting for different costs of living and inflation over time).

This experiment teaches us two very important things:

1) Fungibility of Money: The traditional fungibility of money should be questioned.  Fungibility of money is the idea that, as expressed above, $3 is $3.  So, dollars are fungible if X dollars are equivalent to another X dollars at the same time and place.  But the 46 students that chose to accept the 50% discount on the $6 pen clearly valued their $3 discount more than the 52 students that rejected the same $3 discount when it was applied to a $150 textbook.

2) Transaction Utility: People don’t just receive utility from an object that is received in a transaction, but they also appear to receive utility from the transaction itself (a “good deal”, for example).

Nudging Pitt Students (Pt. 2 – The Results)

In the previous post I talked about the idea behind the LANDFILL label, and why I thought that it could affect behavior. In this post I will talk about our actual experimental results.  Below is a picture of our label on a campus trashcan (click to enlarge):

The Experiment’s Format

  • Observed whether specific recyclable items were trashed or recycled
  • Observed 2 trashcans in separate areas, one adjacent to a recycling bin (“Store Area,” above), the other close to, but not next to, two recycling bins (“To-Go Area”)
  • 4 weeks of data collection (M-F, 2 hours each day)
  • First 2 weeks = control, raw observational data (no LANDFILL label on trashcans)
  • Last 2 weeks = observational data with LANDFILL labels on trash cans
The Results

The greatest part about this experiment involved the fact that none of our subjects had any idea that they were actually participating in an experiment.  This is an issue that experimental economics labs tend to have (people that choose to participate in a study may be more likely to respond to the study’s queues than an average person, for example).

Additionally, the most rewarding part of the experiment was actually being able to see individual reactions to the LANDFILL sign.  And while we did not collect any data on this, we noticed that females were significantly more likely to respond positively (stop to think about their action, or recycle) to the new LANDFILL sign than males.

Here are four graphs of our results (there are eight in the full study – I’m only displaying four to keep this post manageable):

Figure 1 details the base (control – weeks 1 and 2) recycling behavior, because this data was collected before the LANDFILL label was added to the trashcan.  In Figure 2, the data collected was from weeks 3 and 4, and shows a slight yet distinct increase in recycling rates.  In this example specifically, recycling rates increased by 26% after the addition of the LANDFILL label.

Figure 7 details the base behavior with respect to the number of recyclable items that were thrown away.  Paper dominates the graph because the trash can was in the “Store Area” (small convenience store located in the dining hall), and every student that bought something received a receipt, which was typically either thrown away or recycled upon exiting the store.

Similar to Figures 1 and 2, a slight change in behavior is visible.  In this specific example, the rate of discarding recyclable items decreased by 27% after the addition of the LANDFILL label.


  • Overall recycling rates increased by 29%
  • Overall discarded recyclables decreased by 23%

In a future post I’ll take time to provide some analysis, but for now I simply wanted to place all of the data into one, somewhat concise post.  The basic result was that the LANDFILL sign affected behavior, and led to an increased recycling rate (with some limitations).  In future experiments, we will try to tease out the specific effect that the IMPERIAL, PA (17.3 MILES) label has.  I have a feeling that attaching regional responsibility to the label was very important.

– James

Note: Special thanks to Richard Thaler and Cass Sunstein, the authors of the 2009 book “Nudge.” Without their inspiration I may never have founded this organization.  Also thanks to John Balz, the great editor of Nudge’s online companion,, and tolerator of all of my dumb tweets.

Nudging Pitt Students (Pt. 1 – The LANDFILL Idea)

During my short stint as a “Student Sustainability Coordinator” for the University of Pittsburgh, I became aware of an issue known as “cross contamination.”  The basic problem is that a great number of recyclable items tend to end up in the trash, even if a recycling bin is placed adjacent to a trash bin.  The standard “solution” to cross contamination is simply to increase the number of recycling bins in a given area, and hope that cross contamination decreases and recycling rates increase.  But how cost effective of a solution is that if your target area is 132 acres (Pitt’s campus), especially if said campus is already saturated with receptacles for recyclables?  And what about the fact that people will continue to throw away recyclable items even when it is equally as taxing (easy, actually) to recycle them instead?

Surely there could be a less costly plan that would directly attack the cross contamination issue.

Thinking differently, what if the problem is that people are simply thinking about trash in the wrong way?  What if it’s informational?  That is, if we give people a little more insight into the consequences of their actions, maybe their behavior will change.  This is exactly what we decided was the issue, which led to the creation of this label:

The basic idea behind the design (which turned out not to be quite as novel as I had originally thought, see: NudgeBlog) is twofold:

One, regarding the “LANDFILL” part, the hope is that by actually telling people (reframing) what happens to their trash when it is discarded, the act of throwing something away fades from a mindless, passive action and becomes a thoughtful, active act.

And two, the “IMPERIAL, PA (17.3 MILES)” part is a separate nudge within a nudge, one that attaches regional responsibility to an action.  This is accomplished by unveiling the actual location of the landfill where the actor’s trash will ultimately lay.  In the University of Pittsburgh’s case, this is a landfill in Imperial, Pennsylvania (which, of course, is about 17 miles away).  The hope here is that an individual’s pride for their home (Pittsburgh and its suburbs) will motivate them to, in this instance, recycle.

In the Spring of 2011, we piloted this project by placing these labels on two different trash cans in the busiest dining hall on campus.  One trash can was directly next to a recycling bin, while the other was alone, but was about 15 feet from two other recycling bins.  The actual experiment lasted for one month, and we examined the quantity of recyclable items that were both recycled and discarded during our control (first two weeks, no labels) and during the actual experiment (last two weeks, with labels).

Next Wednesday’s post will cover the results from the experiment, as well as any further insight that we gained.

– James

Note: Special thanks to Richard Thaler and Cass Sunstein, the authors of the 2009 book “Nudge.” Without their inspiration I may never have founded this organization.  Also thanks to John Balz, the great editor of Nudge’s online companion,, and tolerator of all of my dumb tweets.

Does Apple Artificially Innovate?

Innovation can have a profound effect on an economy.  A recent Brookings report claims that innovation powers economic development, increases life expectancy, and makes technology (items that are typically quite expensive) more affordable.

But today when I went to charge my iPod Touch, I was confronted with the above yellow triangle warning: ”! Charging is not supported with this accessory”

My first inclination was that the electrical output (5.0 V, 500 mA)  that the Griffin wall charger provides may be either too much or too little for my iPod Touch.

But what about the fact that the charger brought my completely dead iPod back to life?  Only once it had enough charge to function again did it actually stop itself from charging.

Now I am a huge Apple supporter (writing with a MacBook Pro), but what if Apple purposefully changes the requirements for their new products, forcing us to continuously upgrade to new chargers as we upgrade our hardware?  Or what if the requirements aren’t even different among the old and new products?  What if it’s just software blocking the charge, forcing us to purchase another object (a new charger)?

I’m not sure of the answer.

So what is this called?  Artificial innovation?  The word innovation, from its latin roots, means “to renew or change.”  In general, innovation tends to apply to revolutionary ideas or creations that dramatically alter markets, thus allowing for the creation of better things.  Consumers and producers may then purchase these better things to improve their processes or lifestyles.

However in this case, we don’t have anything close to innovation.  The incentive that led to the purchase of an incredibly innovative, new product (iPod Touch) is quite distinct from the incentive to buy a new charger.  One was born out of amazement and a desire to own said amazing technology, while the other is no different than a parent burdening their already well-behaved child with some arbitrary rule.

A few other quirky examples of the tentatively named “artificial innovation”

  • Upgrading to OS X Lion requires a Mac with a Core 2 Duo, Core i3, i5, i7 or Xeon processor
  • Supposedly with more options, come more benefits. But common cable packages are stacked with sports channels, much of which account for 40% of programming fees.  What if you’re not a sports fan?
  • Almost any product that’s labeled “green.” Usually nothing more than a gimmick.

The Beginning

The Innovative Economics Initiative was founded by a pair of Economics students at the University of Pittsburgh this past year. We like to talk about our ideas in the fields of Behavioral Economics, energy policy, choice architecture / Nudging, business innovation and whatever else that may float through our minds.

Like Tweets about the economic genius of Angry Birds? Or the surprising influence of urinals? Check out our Twitter: