Misbehaving: The Making of Behavioral Economics Read Online Free PDF

surveys in which I would hypothetically tell people in version A that they had been given (say) $50,000 did not eliminate the disparity.
    §    Rosett did not seem much troubled by this behavior. I subsequently published an article that included this anecdote, with Rosett described as Mr. R. I sent Rosett a copy of the article when it came out and received a two-word reply: “Ah fame!”
    ¶    Of course, the divinity school students might make up for this disparity in the very, very long run.

4
    Value Theory
    A fter my day in the library, I called Fischhoff to thank him. He told me that Kahneman and Tversky were working on a new project about decision-making that should be right up my alley. Fischhoff thought that Howard Kunreuther, a professor at Wharton, might have a copy. I called Howard and struck gold. He had the draft and would send me a copy.
    The paper, called “Value Theory” at the time, arrived replete with Howard’s comments scrawled in the margins. It was an early version of the paper that would win Danny a Nobel Prize in 2002. (Amos would have shared the prize had he been alive.) In time the authors changed the title to “Prospect Theory.” * This paper was even more germane to the List than the work on heuristics and biases. Two things grabbed me immediately: an organizing principle and a simple graph.
    Two kinds of theories
    The organizing principle was the existence of two different kinds of theories: normative and descriptive. Normative theories tell you the right way to think about some problem. By “right” I do not mean right in some moral sense; instead, I mean logically consistent, as prescribed by the optimizing model at the heart of economic reasoning, sometimes called rational choice theory. That is the only way I will use the word “normative” in this book. For instance, the Pythagorean theorem is a normative theory of how to calculate the length of one side of a right triangle if you know the length of the other two sides. If you use any other formula you will be wrong.
    Here is a test to see if you are a good intuitive Pythagorean thinker. Consider two pieces of railroad track, each one mile long, laid end to end (see figure 1). The tracks are nailed down at their end points but simply meet in the middle. Now, suppose it gets hot and the railroad tracks expand, each by one inch. Since they are attached to the ground at the end points, the tracks can only expand by rising like a drawbridge. Furthermore, these pieces of track are so sturdy that they retain their straight, linear shape as they go up. (This is to make the problem easier, so stop complaining about unrealistic assumptions.) Here is your problem:
    Consider just one side of the track. We have a right triangle with a base of one mile, a hypotenuse of one mile plus one inch. What is the altitude? In other words, by how much does the track rise above the ground?
    FIGURE 1
    If you remember your high school geometry, have a calculator with a square root function handy, and know that there are 5,280 feet in a mile and 12 inches in a foot, you can solve this problem. But suppose instead you have to use your intuition. What is your guess?
    Most people figure that since the tracks expanded by an inch they should go up by roughly the same amount, or maybe as much as two or three inches.
    The actual answer is 29.7 feet! How did you do?
    Now suppose we want to develop a theory of how people answer this question. If we are rational choice theorists, we assume that people will give the right answer, so we will use the Pythagorean theorem as both our normative and descriptive model and predict that people will come up with something near 30 feet. For this problem, that is a terrible prediction. The average answer that people give is about 2 inches.
    This gets to the heart of the problem with traditional economics and the conceptual breakthrough offered by prospect theory. Economic theory at that time, and for most economists today,