Seven of the theses for which Ralph Byrns served as advisor in the past five years have centered on behavioral issues. Cognitive psychologists and behavioral economists question the general applicability of some behavioral assumptions that underpin standard economic theory (SET), which some cognitive psychologists call expected utility theory (EUT). Their research indicates that anomalies for SET are pervasive and that our choices are limited by bounded rationality, bounded self-interest, and bounded willpower. Moreover, our decisions often fail to reflect the systematic risk aversion that economists view as common when choices are risky, and people seem to be risk lovers when confronted with potential losses. [See Susan Fisk's short paper here for a brief overview of the concept of bounded rationality.]
Aspects of behavioral economics are an increasingly important theme in the research of Nobel Prize winners in Economics. These Nobel winners include Herbert Simon (1978), Maurice Allais (1988), James Heckman and Daniel McFadden (2000), George Akerlof, A. Michael Spence, and Joseph Stiglitz (2001) and Daniel Kahneman and Vernon L. Smith (2002). Notable works by Robert Frank (Cornell), Richard Thaler (Chicago – see his Nudge, with Cass Sunstein), Robert Shiller (Irrational Exuberance and Subprime Solution), Steve Levitt (Freakonomics), and Dan Ariely (Predictably Irrational) also have a distinctly behavioral flavor. See also numerous recent Freakonomics articles written by Levitt and Dubner for the New York Times Magazine.
Recent UNC Theses Focused on Behavioral Economics
Risk, Rationality, and Familiarity with Basic Economic Theory
Rebecca Martin, UNC BA with Highest Honors, 2008
This thesis extended the works of Sue  and Samet  to address the issue of whether UNC students arrive at college with a well-developed sense of economic reasoning, or whether some aspects of economic reasoning develop as students are initially exposed to the material in an Introduction to Economics course. [Do entering UNC students with little or no previous exposure to economics but with a predilection for economic reasoning tend to major in economics moreso than similarly inexperienced students without such a predilection?] This thesis examined how students performed on the Kahneman-Tversky questionnaire when administered on the first day of an Introduction to Economics course relative to their performance after taking this course. The K-T questionnaire was administered to roughly 350 beginning students at the start of Spring 2008, and at the end of the fall semester 2007. These data include a lot of demographic information about the students. The resulting database is not yet analyzed.
Alexandra Samet analyzed the K-T questions for how alternative responses conform or fail to conform to standard economic theory versus prospect theory, the label Kahneman and Tversky applied to choices that they perceived as inconsistent with SET. Samet identified several questions that were misclassified by K-T as inconsistent with SET. This thesis would have benefitted significantly by the development of a better questionnaire containing newly formulated questions and only the valid questions from the original K-T studies. This new questionnaire was administered to Intro to Econ students at the end of this semester [Fall 2007], and to new students at the first meeting of Intro students at the beginning of Spring semester, 2008.
Race, Perceptions of Female Attractiveness, and Potential Expected Income
(Sarah Simon, UNC BA with Honors, 2008.)
This thesis extended the work of Fisk by addressing whether the evaluations of attractiveness of females of different races or ethnicities are influenced by the race, ethnicity, gender, or other demographic characteristics of the judges. Another aspect of the proposed research was to try to ascertain whether differentials in perceived attractiveness are likely to be reflected in future incomes. A final question addressed in this research is whether American students differ from foreign students (in, e.g., Hong Kong) in their reactions about how attractiveness might be expected to affect potential income. Outline of the research: The database of Facebook pictures of Caucasian women used by Fisk, randomly chosen, was replaced, with half being pictures of non-Caucasian women randomly chosen, and half, pictures of Caucasian women. Student judges from the University of North Carolina and for Hong Kong were asked to estimate how much they would offer to pay these women if the judges were employers potentially hiring these women as new college graduates.
The idea that underpins parts of this research derives from recently published research results in which individual student volunteers who were paid were, first, asked to estimate how many puzzles they could complete in a given time period, and then these students were tested to see how many puzzles they in fact could solve per period. A panel of paid student judges was asked to assign attractiveness scores to the students who had been tested for proficiency as puzzle solvers. The results of these surveys were that, on average, students with higher attractiveness scores believed they could solve more puzzles than students with lower attractiveness scores, and the panel of judges supported the view that more attractive students were more likely to solve more puzzles. However, the real world test of relative proficiency as puzzle solvers revealed zero correlation between attractiveness and the average number of puzzles solved. These results suggest that more attractive people are more confident that they have significant aptitude for tasks than less attractive students, and by inference, that employers may systematically offer higher pay to potential employees perceived as more attractive.
Susan Fisk, UNC BA with Highest Honors, 2005
Susan Fisk’s study addressed whether women compete more vigorously for the attention of males when the ratio of women to men in a population increases. She had a panel of more than 120 UNC students judge, on a scale of 1 to 10, pictures posted on Facebook by more than 1000 Caucasian female students at more than 20 colleges in the Southern United States. Her major hypothesis was that women would post more attractive pictures of themselves if fewer males were available per female on these college campuses. Other hypotheses considered whether the backgrounds of the judges resulted in systematic differences in the evaluations of these pictures. This link is to a paper Susan wrote that summarizes some of the literature on the economics of beauty, considered behaviorally.
Findings. Susan’s basic hypothesis was not supported by the data. However, three statistically significant results emerged from her analysis of how the backgrounds of judges (i.e., gender, race, and geographic place of residence prior to enrolling at UNC) affected their evaluations of female attractiveness. First, women were more generous than males, on average, in the attractiveness scores that UNC students assigned to the pictures posted on Facebook. Second, the attractiveness scores of Caucasian and non-Caucasian judges were not distinguishably different. Third, geographic region of origin of the judges (i.e., states close to North Carolina versus other states or nations of origin) had no influence on the attractiveness scores. That is, there seems to be no regional differences in perceptions of attractiveness.
Awards: In addition to graduating with Highest Honors, Susan’s work was awarded Best Senior Thesis by the UNC Department of Economics, and she placed second in the 2006 statewide thesis competition at the Duke University Economics Symposium. These accomplishments were remarkable given that her major hypothesis was rejected, and stand as evidence of the strength of Susan’s writing, and the rigorous methodology used in her study.
Alexandra Samet, UNC BA with Highest Honors, 2005
Alexandra Samet’s study focused on whether taking courses in economics or business administration improve the logical consistency and made risk aversion a more consistent pattern. Samet extended the Sue results by having 50 undergraduates majoring in economics and 50 undergraduates majoring in business administration answer the K-T questionnaire. All of the respondents in her study had credit for the Introduction to Economics course
Findings. Samets research strongly suggests that taking more advanced courses in economics or business does not improve the rational consistency of people, nor does it change their treatment of risk. Moreover, Samets results confirmed the results of Sue to the effect that economists are more rational and more consistent in their treatment of risk than are other people, and found that business majors not also specializing in economics were no more likely to be rationally consistent than were liberal arts or science and math majors, nor were they any more consistent in their treatment of risk.
Inasmuch as all of the students studied by Samet had credit for principles of economics courses, further research needs to be undertaken to ascertain if rational consistency and treatment of risk are affected by exposure to introductory economics courses.
Behavioral Analysis of Commercial Bank Mergers: Are Banks Really Profit Maximizers?
Thomas Hodges, UNC BA with Highest Honors, 2005
Tom Hodge’s study addressed whether the restructuring (branch consolidation) that follows bank mergers maximizes profit and the present values of stockholders in the surviving bank. Specifically, when banks with overlapping territories merge and numerous branches of the two original banks are geographically close to each other, does the acquiring bank tend to close branches of the acquired bank instead of the acquirer bank more than standard profit-maximizing assumptions would predict? The unavailability of any comprehensive database identifying the branch consolidations following mergers resulted in this research being a case study of the 2004 acquisition of SouthTrust by Wachovia, and the consequent 173 branch consolidations.
Findings. Hodges found that, after adjusting for the distances between branches, size, and other proxies for expected profitability (e.g., deposits and loan activity), the branches of the acquired bank were twelve (12) times more likely to be closed than the branches of the acquiring bank. This result seems much less consistent with profit maximizing decisions than with how powerfully top managers of acquiring banks conformed to Adam Smith’s principle of the relative influence of custom (i.e., proximity, or familiarity, or affection) when compared to moral sentiments (e.g., utility or profit maximization).
Douglas R. Sue, UNC BA with Highest Honors, 2004
Douglas Sue used the Kahneman-Tversky questionnaire (link) in an attempt to ascertain if economists are more rational than most people, and if they are more consistent in dealing with risk. Sue’s research queried 100 UNC juniors and seniors. One-third were majoring in liberal arts, one-third were majoring in mathematics or the sciences, and one-third were economics majors.
Findings. Sue’s results indicate that people who choose to be educated in economics tend to be more rationally consistent and to treat risk more systematically than is true of students who major in other social sciences (broadly construed) or in mathematics or the sciences.
Awards: In addition to yielding Highest Honors, Doug’s work was awarded Best Senior Thesis by the UNC Department of Economics, and he won a statewide thesis competition at the Duke University Economics Symposium in 2004.
Pricing and Advertising Strategies and Their Effect on Consumer Decisions
Jennifer Wade, UNC BA with Highest Honors, 2004
Jenny Wade secured data covering purchases in a grocery store to test whether the way prices are framed affects consumer behavior, contrary to standard economic theory [SET]. For example, if whether an item’s sale price is stated as 2/$4 versus $2 per unit affects consumer purchasing patterns, then consumers are not acting in accord with SET.
Findings. Wade’s study of more than 100,000 consumer purchases of nine items compared the amounts people bought at regular prices [e.g., $3.19] versus purchases at sale prices [e.g., 2/$4]. When prices were stated as, e.g., 2/$4, customers bought in increments specified in the stated price. In other words, even though 2/$4 translates to $2 per unit, consumers bought 2 or 4 or 6 (etc.) units far more often than they bought 1 or 3 or 5 units. Wade’s results were quite robust, with confidence intervals for seven items at the 99+% range, and for the other two items, the confidence intervals exceeded 95 percent.
Possible Theses Topics for 2009
The Effects of Exposure to Basic Economic Theory on Student Opinions about Political and Economic Issues
This thesis would use surveys to ascertain the opinions of students on 37 questions originally administered for the Washington Post to roughly 1200 PhD economists and a similar number of members of the public at large. Some students will be asked these questions when they initially enroll in introductory economics, in January 2009, but before they have been exposed to economic theory. Other students will be asked the same questions in December 2008, as they are completing their first economics course. This research is intended to ascertain whether exposure to economics courses has a discernible effect on student opinions. Do student perceptions about taxes, international trade, immigration, the state of the economy, the importance of financial markets, etc., change with exposure to economic theory?
Trends in College Enrollments Analyzed by Gender: The Issue of Economic Efficiency
This thesis would address possible reasons for the reversal of college enrollments by gender that has occurred during the past half century or so, and whether the current structure of K-12 education and the criteria for the awarding of scholarships and other incentives to acquire higher levels of education may systematically yield economically inefficient results.
Background: In 1960, roughly 65 percent of all college students were male. By 2007, roughly 60 percent of all college students are female. Moreover, scholarships seem increasingly to be awarded to beginning female students relative to the incentives offered to beginning male college students. The normative criterion of economic efficiency suggests that the expected societal gains from education, including expected gains to the educated individuals, should, at the margin, be equal per dollar spent for all identifiable demographic groups. Recent research suggests that females students tend to learn more if taught by female teachers, and that male students learn more if taught by male students. Moreover, there is some evidence that females mature earlier than males in numerous dimensions, including intellectual and social aspects of personality. In a nutshell, are male students inefficiently disadvantaged relative to female students, if the awarding of, e.g., Robertson or Morehead scholarships is based on criteria that have biases in their predictive values for gains from education, lifetime productivity, etc.?
1. Human beings are self-interested, and they seek pleasure and try to avoid pain.
2. Human beings are rational and forward-looking.
3. Human beings are time consistent –choices at any moment are assumed consistent with choices people expect to make at future points in time.
4. Human beings tend to be somewhat risk averse.
5. Human beings must optimize because choices are bounded by limited resources.
Self Interest and Rational Optimization?
Naïve Egoism: U = U(x1, x2, , xn) [xi = some good]
Present Aim Rationality: U = U(X, Y) [X, Y = vectors]
Production and Resources:
The creation of value (utility?)
Labor / Land / Capital / Entrepreneurship
1. Choices are rational if we expect the consequences to be consistent with our goals. Goals that are inconsistent with each other may also be a symptom of irrationality.
2. Choices are irrational if we know them to be inconsistent with achieving our goals.
3. A behavior is arational if, for example, it entails our tastes -- preferences between chocolate and licorice, for example, or our aesthetic sensibilities.
The conventional economists’ view of behavior: humans are rational and do the best they can with what they have. Mistakes are consequences of imperfect information and imperfect foresight.
Behavioral Economics: Standard Economic Assumptions are Unrealistic.
We are not always good at optimizing. If people were as rational and forward-looking as economists assume, every chess match would yield the same result, which might be a stalemate, or perhaps white would win, or black might win. None of us is smart enough to know with certainty what that ending would be. Numerous paths might lead to the monotonously predictable ending of each game, but every counter to every possible move by an opponent would generate a countermove yielding the same result. Chess would be no more intellectually challenging than tic-tac-toe.
How self-interested are people?
1. Grad students studying economics.
2. Undergrads studying economics.
3. Students with no background in economics courses.
Results? Members of group 3 trusted each other and cooperated most. Group 2 was more trusting and cooperative than Group 1. This raises the issue of whether people who choose to major in economics are inherently less trusting, or does increased exposure to “the economic way of thinking” program students to cynically view others as narrowly self-interested?
How “rational” are people?
Cognitive psychologists Daniel Kahneman [Nobel Prize in Economics, 2002] and Amos Tversky [henceforth, K-H] built a 21 item questionnaire to try to ascertain how rational people are, and how consistent they are in dealing with risk.
The results of the K-T surveys of college students at Stanford. Princeton, Toronto, and Tel Aviv suggested strongly that people are far less rationally consistent and far less systematic in their treatment of risk than economists suppose.
Kahneman’s “Peak-End Rule”
1. First derivatives of income/consumption matter more than levels. It’s not where you are that determines happiness, but the path that you followed to get there. People on an upward trajectory (ex: recent promotions or increases in wealth) tend to be much happier than people at the same level who have recently experienced some type of reversal.
2. People are often poor forecasters of what will make them happy, but they do tend to know when they are happy.
Anomaly: Anomalies are exceptions to standard expectations about events or behavior. In economics, the term anomaly increasingly refers to behavior not in accord with standard economic theory. For example, people who habitually set their clocks or watches ahead a few minutes are exhibiting anomalous behavior, because economic analysis assumes that rational people never intentionally try to fool themselves. Open the prospect theory link for more discussion. Prospect theorists categorize various anomalies as problems of:
(a) framing people sometimes make different choices when the same problem is presented in different ways. Example: If the grocery store cashier rings up on sale microwave dinners at $2 each regardless of whether the price is stated as $2 each or 2/$4 and if people buy more microwave dinners in even numbered lots (2, 4, 6, 8, ) when the price is stated as 2/$4, then framing affects consumer decisions.
(b) nonlinear preferences people may make choices that seem inconsistent with assumptions about preference functions. Consider transitivity. If A is preferred to B and B is preferred to C, then when people choose C over A, they are not behaving in accord with economic rationality.
(c) risk aversion and risk seeking some individuals will simultaneously and knowingly take unfair bets to avoid risk (e.g., by buying life insurance) and unfair bets that increase risk (e.g., playing slot machines at casinos).
(d) source the mechanism may matter even if the probable outcomes of activities are identical. People may pay more for a good because of the way it is packaged than they will an item that they know to be identical but packaged differently, even if they intend to immediately discard the packaging.
(e) loss aversion potential losses loom greater than relatively equal potential gains. The observed asymmetry in these differences is far too large to be explained solely by income effects.
Bounded rationality: Nobel-prize winner Herbert Simon coined the term bounded rationality to describe limits to peoples ability to rationally solve complex problems. Conventional economic theory assumes that every agent possesses infinite amounts of infinitely rapid brainpower to optimally solve every problem. Simon observed that many people fail to understand probabilities, and that people universally lack the ability to process information with consistency, precision, and accuracy. Consequently, Simon asserted that consumers often fail to maximize their utility, and that business decisionmakers often fail to maximize profits, so that behavior should be assumed satisficing instead of maximizing per se. Simon pointed out that instead of the precise maximization assumed by economists, most people rely heavily on cognitive shortcuts, also known as heuristics, e.g., they make lists, or develop rules of thumb. Some conventional economists now recognize that calculation can absorb resources, much as the acquisition of information does, and refer to the problem of computational complexity.
Bounded self-interest: Behavioral theorists use the phrase bounded self interest to describe the phenomenon of altruism. Research indicates that individuals who believe themselves treated fairly in the marketplace tend to engage in charitable activities to benefit other people, contrary to the view that self interest as a motive is narrowly egoistic. (These findings hint that charitable giving is income elastic.)
Bounded willpower: Behavioral economists have observed that individuals frequently exhibit bounded will power, in that people sometimes knowingly act in ways in the short run that they recognize as inconsistent with their long run self interests. For example, a person who smokes may be very aware of the long run consequences of smoking, but procrastinate on quitting despite knowledge of the likely long term consequences. Procrastination and addiction (to, e.g., gambling, drugs, or alcohol.) are among several categories of behavior that reflect problems associated with bounded will power.
Heuristics: Heuristics are the mental shortcuts people use when evaluating decisions because they cannot perform all the mental gymnastics necessary to perfectly process information so that their decisions are mathematically optimal, given all the information that is available and known. An example of the use of a heuristic would be a shopper who eyeballs the contents of a grocery cart to estimate whether or not the shopper has enough cash on hand to pay for the groceries. The shopper could, instead, know the answer with certainty by summing the prices of the items as each was placed in the cart, and continuously adding the appropriate sales tax. The eyeball approach is a convenient heuristic.
Risk aversion: Risk aversion refers to the relative willingness of people to choose alternatives with lower expected (probabilistic) values if their choices reduce uncertainty. Decision-makers who exhibit this characteristic are termed risk averse. The extent of risk aversion is roughly measured by the expected value an economic agent is willing to forego to gain greater certainty. Risk-averse individuals are willing to make only bets that hold the prospect of loss (as opposed to merely holding onto their money) only if the bets are unfairly weighted in their favor. The assumption that people are consistently risk aversion is a workhorse of neoclassical utility theory, but research in the area of prospect theory increasingly calls this assumption into question.
Risk lover: Individuals are described as risk seeking if they are willing to choose alternatives with lower expected (probabilistic) values in order to increase the possibilities of gain. Risk-seeking individuals (also known as risk lovers) are willing to make a bet that is unfairly weighted against them. A risk seeker will accept an expected payoff of less than X in preference to the certainty of X. Suppose, for example, that you have a dollar that is yours to keep if you don’t make a bet. If you were a risk seeker you might buy a $1 lottery ticket on which the odds of winning a million dollars were only 1 in 5 million.