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Mind Over Money

I started watching the Nova episode called Mind Over Money. I generally like Nova but this episode was far below their normal standards.

The episode is supposed to be about the idea that traditional economists base their calculations on “rational people”. They claim stuff like people are supposedly perfectly rational when it comes to money and will never pay more for something than it’s actually worth. They then go on to give several massively convoluted examples. They say things like “people take their the interest rate of their retirement plan into account on every purchase” or something like that. They’re basically claiming things no economist has ever claimed.

The idea isn’t that people think of those things directly. It’s that those things, somewhere, in the back of their mind, influence their behavior so that the average behavior matches what it would as if they had made those kinds of calculations. That’s no different than me thinking I’m saving for a house and therefore maybe I shouldn’t buy that $800 bag today (not that I’d personally ever buy a $800 bag but I certainly know lots of young women that would). I may or may not have set a budget for myself but most people know their limits and those influence how much they are willing to spend for any given thing.

Nova starts by showing this experiment where people are bidding on a $20 bill. They claim the only rational thing to do is bid no more than $20 and then expect you to be shocked when the highest bid is $28.

The first thing they didn’t take into account is the fact that most people don’t want to be a loser and also that most people want to winners. So, paying more than $20 for a $20 *IN AN AUCTION* can just mean that the people bidding are putting a dollar value being the winner and not being the loser.

This is no different than deciding to take a cab home when you could take the bus or walk. It’s not un-rational to pay $7 for a cab when the bus would be $2 or walking would be free. You’re paying for the convenience and that happens to be worth the cost of the cab to you. For some people that convenience isn’t worth the price of the cab. For others it is. Just like for some people paying a few dollars more than $20 for a $20 bill is worth it to feel like winner.

The second problem is the experiment rules, which they glossed over, were that the second highest bidder also had to pay. That means if you bid $19 and someone bids $20, if you don’t raise the bid then you pay $19 for nothing while he pays $20 for $20. That means you lose $19 and he loses nothing. Obviously you’re going raise the bid at that point. The whole thing changes from trying to bid for $20 to trying pay the smallest penalty for losing. If the bid is $25 to $24 then the guy who is bidding $24 will be out $24 if he doesn’t raise. The guy at $25 is only out $5. So the guy at $24 is obviously going to raise.

How can Nova be this stupid to use this experiment and claim that it shows people being irrational when they are being perfectly rational.

A few minutes later they show another experiment where people are asked if they would take $100 in a year or $102 in a year plus 1 day. Everyone picks $102. They then change the question to $100 today to $102 tomorrow and everyone picks $100 today. Since in either case the different is just a day they try to claim this is irrational but it’s not. It’s perfectly rational.

There are 2 factors at play. In the first case, the difference between waiting 365 days vs 366 days is 1/366. If you already have to wait 365 days, adding 1 day is not much. In second case, get $100 right now or $102 tomorrow, any waiting is infinitely more than no waiting. Think of it this way. If you only have $10 and something costs $5 that’s a huge difference than if you have $1000 and something costs $5. In the first case you have to give up 1/2 your money. In the second you only give up 1/2 a percent. Even though they are both $5 purchase their’s a huge difference the situations.

The second issue is one of risk. If you’re not going to give me the $100 for 365 vs 366 days, the risk I’ll actually get the money is about the same. I have no idea if you or I will be around, alive or trustworthy so it really doesn’t matter if it’s 365 days from now or 366 days from now. But if you offer me $100 now vs $102 tomorrow, I know if you give it to me now it’s mine and I don’t know that you won’t die by tomorrow or won’t show up tomorrow or that I will be able to make it tomorrow so it’s certainly rational to take the $100 now at zero risk than $102 tomorrow at some risk.

Again, I can’t believe Nova used such a bad and false example to support their claims.

Some of the other experiments are better. The ones about anchors do make sense. A good example of that in the real world is how marketers will bracket things. If you go to a store to buy say some kitchen appliance, like say a blender. You go in and there are 3 blenders. A $50 blender, a $100 blender and a $200 blender. Often the truth is that no one ever buys the $200 blender. It’s sole purpose is to *bracket* the prices so that you’ll think, hmmm, I don’t want to be cheap and get the cheapest one and $200 is too much so I’ll get the $100 one. In reality the $50 one is probably fine but seeing the $200 one makes you comfortable buying the $100 one.

They show yet another experiment where people are asked to value a mug and then are given one for free. An hour later they are asked how much they’d sell the mug for and they average 50% more than they said it was worth earlier. The show claims this is irrational. It’s not irrational. Once they received the mug most of them will start thinking of how and when they are going to use it. To give up the mug now means not only the cost of the mug but also the cost of replacing the mug for the uses they are or were expecting to use it for. That’s what’s reflected in the higher selling price. If I have the mug and I’m thinking I’m going to use it to carry my coffee on my commute tomorrow then if I sell it I’m going to have to drive to some store to get a replacement or else change my plans. That added effort accounts for the difference and is completely rational.

The show was full of ridiculous claims about rational markets, setting up false dichotomies and making false claims similar to the false conclusions of the experiments above. They seemed to be trying to say that people were irrational and that caused the 2008 bubble and crash. But it didn’t take irrational thinking to cause those events. People were doing what’s rationally in their own best interest. If everyone rationally thought the market was going to crash they wouldn’t have invested. And once it did crash they rationally attempted to take their money out before it was lost.

The show also seems to be claiming that rational markets always keep prices at exactly the *correct* price all the time. No one, other than Nova, has ever claimed this. The claim is that rational markets correct themselves which is exactly what happened. The bubble was burst. That’s the correction. Hello? What don’t they get?

Like a Micheal Moore film, they take comments out of context. For example they show one defender of the rational markets theory saying that “the observation that people yield to emotions means nothing and if you’re going to just say that markets went up because there was a wave of emotion you’ve got nothing. That doesn’t tell us anything about what circumstances are likely to make markets go up. Now that would not be a scientific theory.” They seems to be trying to use this as evidence that rationalist are ignoring reality. Again this is false. The guy is not saying that emotions don’t enter into it. He’s saying what we need to know is what what circumstances effect the market. So for example the death of Princess Di might have effected the market. Why, because people were sad and not shopping. But it doesn’t matter that the process is because of emotion. What matters is that famous and loved people dying effect the market whether or not it’s because of emotion or something else.

It generally seemed like a big piece of propaganda instead of the usual science that Nova is known for. That’s really sad. Nova should stick to science. Let Frontline offer the propaganda.

  • http://none CDL

    Kudos to you for “THINKING.”

  • http://www.theamazingdayspa.com mitchcp

    Interesting…I’ll rather have a check this Nova :)

  • Tedhughes@occaustin.com

    I googled “nova mind over money rediculous” and came upon your blog. I’m glad I’m not the only one slapping my forehead. I like nova, love frontline, and am an avid pbser. Behavioral economics has been around a while, and has actually produced a lot of interesting, and important research with practical implications. Nova decided to show only economic magic tricks with no real conclusion other than you can trick people into making bad decisions. That isn’t under debate. No economist, Chicago or other, believes that people are perfectly rational, or even mostly rational.
    I feel like they are trying to be animal planet. Dumbing down anything tout provoking in lieu of sensationalism. Glad to hear I’m not alone