The television show "Deal or No Deal" has gained enormous popularity in recent weeks, winning the avid attention of millions of viewers--and economists.
The game show has simple rules: a single contestant must decide, in up to nine rounds, whether to accept a "bank offer" of a specific amount of cash, or to accept the result of a well-defined lottery. This simple structure makes an economic analysis of contestants' decision-making process unusually feasible.
This National Public Radio segment describes how University of Chicago behavioral economist Richard Thaler, together with a team of researchers from the Netherlands, has analyzed results from 53 episodes of the show. (You can download the academic paper here. The math gets a little heady, but the bulk of the paper is quite readable.)
Behavioral economists like Thaler are interested in how psychology plays into people's economic decision-making processes. The kinds of behavior observed in contestants on a game show, or students in an economics lab, often provide insight into phenomena that affect financial markets and other more "traditional" economic arenas. For example, Thaler and his co-authors find an interesting result in the data: that the more unlucky a contestant is early on, the more he or she is likely to engage in risky behavior in later rounds to achieve a psychological "break-even point." Thaler describes in the NPR piece how this behavior is also observable among mutual fund managers, saying that those "who are trailing their benchmarks in the fourth quarter take on more risk than those who are ahead of their benchmarks."
1) People are often willing to pay for car insurance, even though the expected loss they would incur in a year is less than the amount they have to pay in premiums. Given a choice between taking $10,000 for sure and a 50% chance of $20,000, what do you think these people would do? Do you think that would change if they were on a game show?
2) Suppose you're playing a game like poker or blackjack. You start out with $100 and lose $80 of it. Would you walk away from the table? What if you had gained $80? How might your own behavior in such an environment shed some light on financial markets?
3) One class of behavioral economic models is called "bounded rationality." Rather than assume people are rational, it assumes that they are irrational in some specific way. For example, consider two identical contestants facing a choice between $10,000 for sure and a 50% chance at $20,000. For one of them, this is the first offer they are given. For the other, this offer comes just after losing a chance to win $1 million. Despite the fact that the two face identical problems now, according to Thaler, the one who lost the chance at $1 million may be more willing to take the gamble because their recent loss puts $10,000 in a different perspective. What other kinds of economic phenomena do you think this kind of analysis would help to illuminate?
P.S. For students interested in doing a bit more (ahem) research into the game, you can play an online version of it here.
Topics: Risk and uncertainty, Behavioral economics, Bounded rationality