Wednesday, 13 December 2017 | 12:41 WIB

Deconstructing Human Irrationality through Behavioral Economics

Richard H Thaler, the winner of the 2017 Nobel Prize on Economy (vibiznews)

JAKARTA, NETRALNEWS.COM - Humans, including me and you and everyone else, basically like to think irrationally or irrational. So says Prof. Dan Ariely - behavioral economics expert - in his famous book Predictably Irrational.

During this time, we always feel that we always thinking rational and objective. Unfortunately, this feeling is just a fantasy.

We as human beings turn out to have so many biases or thinking errors that we often do not realize, and make our decisions in many ways that become chaotic.

What are the thinking errors? Let's snatch this bright morning.

This morning, I was inspired to write an article about the science of Behavioral Economics because last week one of the experts, Prof. Richard Thaler was crowned as the Nobel laureate of the economy 2017.

Prof. Richard Thaler who is also a lecturer at the Faculty of Economics University of Chicago, is a figure who is considered as the Father of Behavioral Economics.

Behavioral science economics itself is one of the new branches in economics. The basic premise of behavioral economics is: the human being is irrational, and likes to include the emotional element in economic decision making.

The view is of course the antithesis of conventional economics which has had human assumptions are always rational in taking economic decisions.

That is why many conventional economists are somewhat embarrassed by behavioral economics: because this approach makes the classical economic assumptions collapse and collapse.

Behavioral science economics itself is built through a combination of economics and psychology. That is why the gods in behavioral economics are mostly psychologists such as Prof. Daniel Kahneman (who also won the Nobel economics of 2002), and Prof. Richard Thaler himself.

Through research conducted by behavioral economics experts, found a variety of bias or systematic thinking error which often slipped behind our hearts.

The silence of the various biases makes our decision making no longer objective and rational. The bias makes us - me and you - repeatedly errors that are systematic, and often make our lives nyungsep in the darkness of fate.

There are many types of error thinking traced in behavioral economics research. I will try to review 5 of them. Let's track while accompanied by a cup of warm tea.

Error Thinking # 1: Loss Aversion

Dozens of studies in behavioral economics science proves that we humans tend to be too afraid of potential losses, compared to the potential benefits to be achieved.

The phenomenon is referred to as loss aversion - or too concerned with potential losses.

People everywhere in the world are indeed afraid to take risks. We are all more afraid of potential losses; rather than eagerly pick up profit opportunities.

In one study even revealed the pain we will lose was more imprint in the heart than pleasure due to profit.

In other words, the 10 million loss experience turned out to be much longer in the heart, compared to the feeling of happiness resulting in a profit of 10 million.

Loss aversion might be able to explain why the majority of people are hesitant to start a new business independently.

Even before starting a business, most people are afraid to go ahead. Afraid lest maybe even loss. Do not let my business fail.

Loss aversion which may also explain why most people are rather pessimistic with the chances of successes they will have.

Error-thinking of this kind that can make our life become tougher later on.

Error Thinking # 2: Endowment effect

This effect essentially means you are too appreciative of excessive items you've bought or that you already have.

Once you buy or have something, you suddenly feel a sense of love for the item, and consequently you give a higher value than the market price or real value.

Suppose you have a new Honda Jazz. After a while, you want to resell it. You will most likely offer a much higher bid price than the market price. You who own the car tend to provide a higher price assessment than the actual market price.

Another example of endowment effect: You buy Telkom’s shares for example. After a few months it turns out the price dropped. But because of the effect of endowment effect, you do not immediately cut loss. You continue to overstate and justify your purchase, though the longer the price falls.

Another example: You are involved in a project. After a while this project is actually a loss, but you still invest the remaining energy, thoughts and funds to continue this losing project.

Why do not you cut right away? Because there is an endowment effect, you feel dear if the project is actually losing your losses in the middle of the road.

Endowment effect is what makes Nokia and Kodak’s business collapse.

They are caught by endowment effect: too much love their own products. Too proud and overstate his own product, so ignore the sudden changes around them.

Too much love will kill you. Apparently this romantic expression is true, which is proven through studies in behavioral economics science.

Error Thinking #3 : Confirmaton Bias

This error essentially lies in you being stuck on your favorite choice; thus ignoring alternative options. You just want to read the information that confirms the truth of your favorite choice.

Example: You already like a certain smart phone brand. So while browsing for information about a new smart phone, you are selecting the information you want to read. You tend to focus more on finding information that justifies the power of your favorite smart phone; and ignore the information that criticizes the power of the smart phone.

Confirmation of this bias is very massive occur during the general elections. When you already have a favorite option, then you will only want to read the information that justifies your choice; and are reluctant to read or unexpectedly emotional while reading information that does not fit your choice.

All camps are stuck confirmation bias. Then a rational and objective choice becomes difficult when everyone is stuck with this kind of error thinking.

Error Thinking # 4: Herd Behavior

Studies in behavioral economics find this dark fact: humans, me and all of you, actually like to act like a flock of ducks. One turns to the left, they all turn to the left. One turns to the right, they all turn to the right.

We all like to be talkative. We have behavior that likes to mimic the crowd and people around us.

This herd behavior gives rise to mania, a momentary trend or uproar over something. The crowd grows noisier.

Busy roadside food stalls, will be more crowded. Stores and hawkers with long queues will certainly attract more visitors.

Books that are labeled best sellers will definitely increase sales. The more attractive the investments, the more people that interested will come.

These are all herd behavior phenomena. Because you and I really like talkative and curious about what many people like.

Error Thinking # 5: Survivor Bias

This bias occurs when we draw conclusions based on invalid data. Why not valid, because we often read only the survival or successful survival stories, while stories of failures are are rarely reported.

Example: Steve Jobs, Bill Gates and Mark Zuckerberg are all drop out students. However, they are successful. Some people would then say, do not be afraid to drop out, because you can succeed as well as them.

Such a statement is an example of a mind trapped by a survivor bias.