Putting decison-making in context

A while back I wrote about how it takes all sorts to make a world and why we need to account for those different sorts in our models of it. One of the things that I highlighted in that post was the need for mainstream economics to acknowledge and use more of the findings from behavioural economists.

One of the examples I used in the draft of the book chapter I have been writing for the second edition of Wainwright and Mulligan's Environmental Modelling was the paper by Tversky and Kahneman, The Framing of Decisions and the Psychology of Choice. They showed how the way in which a problem is framed can influence human decision-making and causes problems for rational choice theory. In one experiment Tversky and Kahneman asked people if they would buy a $10 ticket on arriving at the theatre when finding themselves in two different situations:

i) they find they have lost $10 on the way to the theatre,
ii) they find they have lost their pre-paid $10 ticket.

In both situations the person has lost the value of the ticket ($10) and under neoclassical economic assumptions should behave the same when deciding whether to buy a ticket when arriving at the theatre. However, Tversky and Kahneman found that people were more likely to buy a ticket in the first situation (88%) than buying a (replacement) ticket in the second (46%). They suggest this behaviour is due to human 'psychological accounting', in which we mentally allocate resources to different purposes. In this case people are less willing to spend money again on something they have already allocated to their 'entertainment account' than if they have lost money which they allocate to their 'general expenses account'.

More recently, Galinsky and colleagues examined how someone else's irrational thought processes can influence our own decision-making. In their study they asked college students to take over decision-making for a fictitious person they had never met (the students were unaware the person was fictitious).

In one experiment, the volunteers watched the following scenario play out via text on a computer screen: the fictitious decision-maker tried to outbid another person for a prize of 356 points, which equaled $4.45 in real money. The decision-maker started out with 360 points, and every time the other bidder upped the ante by 40 points, the decision-maker followed suit. Volunteers were told that once the decision-maker bid over 356 points, he or she would begin to lose some of the $12 payment for participating in the study.

When the fictitious decision-maker neared this threshold, the volunteers were asked to take over bidding. Objectively, the volunteers should have realized that - like the person who makes a bad investment in a 'fixer-upper' - the decision-maker would keep throwing good money after bad. But the volunteers who felt an identification with the fictitious player (i.e., those told by the researchers that they shared the same month of birth or year in school) made almost 60% more bids and were more likely to lose money than those who didn't feel a connection.

Are we really surprised that neoclassical economic models often fall down? Accounting for seemingly irrational human behaviour may make the representation of human decision-making more difficult, but increasingly it seems irrational not to do so.