Behavioral Economics, Ep. 2: How Do Heuristics Help Distinguish Bad Choices From The Good?

Release Date
August 17, 2016

Topic

Basic Economics Economics
Description

Here’s why we we eventually stop searching for soulmates… and shoes.
How is it possible to make a rational purchase decision without seeing all the possible options? Humans have evolved low cost shortcuts for increasing the odds of finding the better options. The shortcuts are called Heuristics. Professor Antony Davies of Duquesne University and Erika Davies of George Mason University explain. Watch the entire series at http://hayekandchill.com/economics/.

Behavioral Economics (playlist): Heuristics, cognitive biases, public choice– oh my! Watch the entire series to learn more about behavioral economics at http://hayekandchill.com/economics/
Predictably Irrational (book): From drinking coffee to losing weight, from buying a car to choosing a romantic partner, we consistently overpay, underestimate, and procrastinate. Yet these misguided behaviors are neither random nor senseless. They’re systematic and predictable—making us predictably irrational. 
Economics Made Easy (playlist): Want to learn more about how the economy works? Check out our playlist for videos on immigration, the minimum wage, and much more!  

>> One of the wonders of the modern economy is all the variety available. Think about shoes. Humans invented shoes tens of thousands of years ago. Over those thousands of years, the shoe hasn’t changed much. Yet, despite how simple they are, the number of varieties of shoes is almost uncountable.
 
There are so many that you could sit in an auditorium with hundreds of people, and still be wearing a unique style of shoe.
>> Human is like variety, and shoes aren’t the only thing that come in many varieties. So too does everything from pencil and cookware to computers and cars.
 
But in an abundance of variety presents a paradox of choice. How can a person make a rational choice when the number of options is so large that the cost of searching for the best option exceeds the benefit of finding it.
>> Notice that a person actually makes two decisions.
 
The first is the search decision, to keep looking for better shoes or to stop. The second is the purchase decision, when done searching which pair to buy. At some point, he will have looked at enough shoes that even though he knows there must be better ones out there, it just isn’t rational to keep searching because he’s already found a pair that is good enough.
 
Humans do this all the time. We choose colleges without having researched all possible colleges, we choose life partners without having dated all available people, we buy houses and choose jobs without having looked at all possible houses or all possible job openings. We know that beyond some point, it is actually irrational to keep searching.
 
>> How is it possible to make a rational purchase decision without seeing all the possible options? Humans have evolved low cost shortcuts for increasing the odds of finding the better options. The shortcuts are called Heuristics. When faced with more options than can be explored, Heuristics help people distinguished the better options from the worst one.
 
>> For example, suppose, you want to pick a college, there are thousands from which to choose and each is unique in some important way. To really research all the important attributes of all the colleges would require years of work. Even if you bought a book that contained every detail of every college, these details are likely to have changed by the time you’re finished reading.
 
How is it possible to make a rational choice?
>> One thing you could do is to ask people you know where they went to college, this is a Heuristic By asking other people what colleges they chose, you’re setting these people up as proxies for yourself. You’re relying on their experiences to inform your decision.
 
Hoping that your experience will be similar to theirs.
>> Another useful Heuristic is the one we use when we judge alternative options relative to one we are familiar with. People use this Heuristic often in selecting a life partner. Rather than attempt to compare and contrast the attributes of all eligible partners, we select one, sometimes at random, to date.
 
We date this person until someone better comes along. Then we date that person until someone even better comes along. We keep doing this until we make the rational decision that it isn’t worth looking any further, and we marry the person we’re dating. This Heuristic is useful because it is easier to compare two things and judge which one is better, than it is to select the best from among a large set of things.
 
>> Faced with the problem of choosing an option when the act of choosing is costly
>> Humans have evolved Heuristics, shortcuts that employ their own past experience, and the experiences of the people around them to help them make more rational choices. This is just one example of how humans rely on each other to make decisions in this complex web we call, the Economy.