Nudge

Richard H. Thaler and Cass R. Sunstein, “Nudge (Improving Decisions About Health, Wealth, and Happiness)”, Penguin Books, C2009, Pages 271

Every day, we make decisions on topics ranging from personal investments to the meals we eat; unfortunately our choices are often poor.  Economists and their economic models portray us as completely rational beings who weigh each decision, otherwise their math wouldn't work.  However, most of our actions do not involve reflection, they are more automatic and use heuristics (shortcuts).   Although these shortcuts usually work well, they can lead to serious error. This book illustrates that by knowing how people really think, we can design choice environments that make it easier for people to choose what is best for themselves; the authors call this libertarian paternalism.

Heuristic is an adjective for experience-based techniques that help in problem solving, learning and discovery. A heuristic method is particularly used to rapidly come to a solution that is hoped to be close to the best possible answer, or 'optimal solution'. The first three heuristics ever documented are:
• Anchoring: During normal decision making, individuals anchor, or overly rely, on specific information or a specific value and then adjust to that value to account for other elements of the circumstance. Usually once the anchor is set, there is a bias toward that value.
• Availability: people assess the likelihood of risks by how readily examples come to mind rather on the actual probabilities that those contemplated risks can happen.
• Representativeness (or similarity):

Nudge is authored by two University of Chicago professors: Economist Richard Thaler and Law Professor Cass Sunstein. They explore the policy implications of behavioral economics, a field describing the irrationalities of human behavior. Taking findings from psychology (e.g. people procrastinate; they’re averse to losing money), Thaler and Sunstein propose policies to help us make the best decisions, in light of our irrational tendencies. In a classic example, they suggest we design 401k plans to require “opting-out” rather than “opting-in,” thus encouraging (nudging) people to save by default.
• The core idea of behavioral economics—that humans don’t behave like rational economic agents-- is several decades old and is attributed to the work of Daniel Kahneman and Amos Tversky. Nudge goes beyond psychological research to suggest concrete ways to improve public policy in light of experimental findings; Sunstein has just joined the Obama administration in May of 2009.
• Humans are bad at long-term planning: but what if cars came with stickers tallying the monthly cost of gas over the next five years: sticker shock might lead buyers to a more efficient car? Or what if we “nudged” people to conserve energy by showing how their energy use stacks up with that of neighbors? Thaler and Sunstein cite an experiment in which residents of a Southern California town reduced their peak usage by 40% once they were nudged to compete with households next door.
• It’s not hard to imagine other psychological tricks to encourage energy (or financial) savings. What about a thermostat that displays the cost per hour of raising the heat by one degree, as Thaler proposes in a 2008 talk at Google?
• The strength of Nudge lies in the insight that there exists a third way in designing social policies while preserving market forces and individual freedoms. We need not go whole-hog in order to eke out efficiencies, whether in personal savings or recycling. While Energy Bill talks bounce endlessly through Congress and Kyoto stalls out at the starting line, city governments, technology innovators and homeowners are coming up with smart ways to use our irrational tendencies to our (and the planet’s) advantage.
• Behavioral economics has laid the groundwork for injecting observed human behavior into the old models.

Additional Notes:

Pg. 33: People hate losses (and their Automatic Systems can get pretty emotional about them). Roughly speaking, losing something makes you twice as miserable as gaining the same thing makes you happy. People are loss-averse causing them to often sell low and buy high.

Pg. 35: The combination of loss aversion with mindless choosing implies that if an option is designated as the default,” it will attract a large market share. Default options thus act as powerful nudges. Setting the best possible defaults is a theme of this book.