I had once posed the following question to my colleagues, ” If I told you that there are certain disease germs in the air which had a 1 in 1000 chance of killing you in the next 10 years and I had a vaccine for it, how much would you pay for that vaccine?”
Answers ranged from 5,000 to 20,000 rupees.
I then posed the question, ” How much would I need to pay you to ask you to go into a room where you had a 1 in 1000 chance of contracting a disease which will most certainly kill you in the next 10 years?”
The answers: 100,000 to ” I am never going into such a room.”
Though the situation in both cases is same from a standard Economic viewpoint, however, most people were clearly more unwilling to take an additional iota of risk than to reduce an already existing one.
This is called ” Loss Aversion”
Another one- A common standard advice to curb excessive spending was to use cash instead of debit or credit cards.
The standard explanation was that you use cash more judiciously.
However, there is no reason to do that. Money spent as cash is equivalent to money spent as credit or debit card.
The reason is ” mental accounting” where money that comes out of a smaller mental account i.e. our wallet causes more pain than what comes from a larger mental account i.e. our bank account, though in both cases, we are drawing upon the same financial reserve.
Another one- Every Sports Fan knows about players who are bought at extreme prices but turn out to be complete duds.
This is called ” Winner’s Curse” where the winner of a common value auction actually ends up losing because he is the one most likely to overpay.
This is often seen with Oil Companies bidding for Fields as well as Corporate Mergers.
All of the above and more have been explored in detail by the winner of this year’s Nobel Prize in economics, Richard Thaler.
Richard Thaler has been a pioneer in the field of Behavioral Economics.
A lot of his theories are actually pretty simple and quite intuitive to the Common Man but often falls beyond the bounds of Standard Economic Theory.
He has written several books exploring our cognitive biases which cloud our thinking.
A well-deserved Nobel Prize indeed.