Humans, Not Econs: 3 Econ Lessons to Avoid Buyer’s Remorse

Newsflash: We humans are not always rational decision-makers. We make some questionable economic (and other) choices, because, in Nobel prize-winning Professor Thaler’s words, ‘We are humans, not econs’.

We operate in a world of sales pitches and marketing traps. To avoid severe buyer’s remorse, we would be well served to understand three fundamental concepts in Economics articulated further in this article.

Now, just because you see the words ‘Economics’ or ‘concepts’ doesn’t mean you should stop reading. I’ll do my best to make this as less dreary as possible. My goal is to help you learn something useful today. Or at least, provide you with enough jargon so you can sound very erudite in your dinner party conversations.

Shopping Trip

Let’s say you’ve been a trooper: you finished your long project, got your exercise in, walked the dog, etc. You feel accomplished. To reward yourself, you head to the mall. Quaint. I know. But stay with me.

You venture out with $50 reserved in your left pocket for clothes-shopping and $15 in your right pocket to spend at the food court. As you enter the mall, someone hands out a free $5 voucher (expiring the same day) to spend at the food court. Do you now:

Choice A

Move $5 from your right pocket to left pocket (to increase your shopping spend to $55) while still being able to spend $15 at the food court - $10 of your own money and the $5 free voucher?

Choice B

Restrict yourself to spending $50 clothes-shopping but plan to get yourself an extra dessert using the free voucher, thus spending $20 on dining?

Choice C

Move $5 from the right (dining) pocket to a third pocket in your shirt to save for future use? (Yes, you’ll need to picture yourself wearing a pocket-heavy outfit). This will still let you spend what you originally intended i.e. $50 on shopping and $15 on dining (using $10 of your own money and the $5 free voucher) but also save $5 for next time.

Decision Time

Have you made a decision yet?

I’m guessing it was a little tough. You may not be able to make a clear choice right now and your decision may vary depending on several factors – how attractive the shopping choices are, how hungry you are, what’s in the food court, and also your general proclivities to sticking to a budget or saving money.

Now, let’s say, I up the ante. The $ value available to you for shopping is now $500 instead of $50. Everything else stays the same. Would your choices between A, B, and C differ?

Likely, right?

The extra $5 in additional shopping money now seems quite inconsequential, doesn’t it? You are not probably not going to spend time debating a spending decision where the added value isn’t that much more.

Here’s the thing about money – the dollar bills that are in your left and right pockets are interchangeable. The same $ will spend equally well on food or clothes or lottery tickets. But we tend to treat it differently, because we are humans, not econs.

Concept 1: Fungibility and its failure

Economists refer to this interchangeability as the fungibility of money.

They say a dollar is a dollar is a dollar. Ad infinitum.

But we create mental accounting categories and start to believe that shopping dollars are different from dining dollars. Or that gifts or vouchers we receive are somehow less money than earned dollars.

This is most apparent on game shows or in gambling.

If you want to watch some incredulous financial behavior, simply tune in to a game show such as ‘Who wants to be a millionaire’ or any of the other shows that require you to stake or risk a percentage of winnings to attempt a shot at the next level.

Jack proves he knows Jack

Let’s say our contestant is Jack. Jack’s annual income is $75,000. Jack knows enough trivial facts to be a strong contestant on ‘Who wants to be a millionaire’. Midway through the show, he’s on a roll and has won a total of $180,000. The crowd is getting behind him.

Jack then is faced with a tricky question. If he cannot answer correctly, he risks losing $150,000 and may have to go home with $20,000. But he’s playing for a chance at doubling his winnings to $360,000.

What does Jack do? He decides to go ahead and risk 150K anyway - two years of his annual income on a single question.

Jack  reasons that the $150,000 he bet, is not HIS money but rather ‘play money’ or in gambling-speak ‘house’s money’. He reckons the remorse in losing play money won’t be quite as bad as losing his own money.

Jack’s behavior violates the fundamental economic law of the fungibility of money. Because Jack belongs to the category of humans, not econs. 

Making a $150,000 bet on a game show is like writing out a blank check for that amount and leaving it on the table in the hope that no one else finds it. Jack would never leave a check sitting out like that.

But his behavior with ‘winnings’ instead of ‘earned’ money is quite the contrary. Why so?

Humans, Not Econs

This behavior was explained by Richard Thaler, Professor of Behavioral Economics, who won the Nobel Prize for his work in this field.

Professor Thaler described how humans behave in ways that are not always rational. Previous economic theories assumed us to be Econs - essentially a figment of economists’ imagination of us being completely rational-choice making machines. Which we are not.

Our irrational behavior is because, we are humans, not econs.

I used to skeptically think people get awarded the Nobel prize for writing arcane theories with highfalutin words to impress their fellow academics. Dead wrong. Nobel laureates are brilliant women and men who, either discover amazing things or who explore common real-life situations and find exceptional meaning in them.

Prof Thaler challenged common belief (that humans make rational decisions) in the world of economics by incorporating how human psychology plays a role in economic decisions. Thus, was born the field of ‘Behavioral Economics’.

Takeaway

Because of our human-ness, we are governed by various behavioral, neural, and emotional factors and don’t always act rationally when making economic decisions.

Irrational is what we are. Humans, not Econs.

The point of this article is for us to be aware of this irrationality. While it’s hard to combat this irrationality and work against our ingrained tendencies, the awareness of economic theories can help us step away from potential financial mishaps. For instance, just acknowledging we are not rational can help us pause when making life-changing economic decisions to avoid buyer’s remorse.

We know money should be fungible. But we act in ways that question our knowledge of fungibility.

Concept 2: JND - Just Noticeable Difference

You’re stuck, working from home, during the pandemic. In reorganizing your office space, you put away your weighing scale, to make space for ‘essentials’. But the fitness tracker remains on your wrist, thanks to your spouse’s insistence.

When your fitness tracker signals it’s time to stand, you decide to take a walk – to the pantry. This has become your new routine. The number of pantry visits has risen in proportion to the number of work-related Zoom calls you take.

Obviously, with each pantry visit, cells are being added to your midsection that neither you nor your spouse notice. Normally, you’d observe this increased, because your clothes would fit tighter. But in these revised circumstances, how would you know? You haven’t worn anything other than very forgiving PJs for many months now.

A few months into the routine, you head to the grocery store to supplement your pantry stock.  There, you run into a coworker. Now, this coworker notices that you are more rounded than you were before but says nothing. Because, polite!

Then, you overhear her conversation with someone on the phone. She mentions running into you and how you’ve gotten stockier. What?!

Back home, you ask your spouse if you’ve gotten chubbier. He says he hadn’t noticed. You badger him to tell you the truth because you know he’s trained to say what you want to hear. A great poker player, who never shows his hand. He insists you’re not chubbier.

Then you ask your child. Same response.

You just got Weber-Fechnered! The What?

Weber-Fechner Law

Definition/Nerd speak: The intensity of a sensation is proportional to the logarithm of the intensity of the stimulus causing it.

In other words, to notice or perceive a change, the intensity of the change should be significant in comparison to the original. Small changes over some time are not noticeable but significant changes are.

Your weight may have slowly crept up and may not be noticeable to people who see you day in and day out, but someone seeing you after a long time, may notice this difference.

Here are some other examples of Webner-Fechner law.

Assume your wallet has $100 in $5 bills. If someone removes two $5 bills from your wallet you probably won’t notice it. Now assume your wallet only has $10 to start with (2 $5 bills). If these $5 bills were removed, it would be VERY noticeable.

In both cases, you ‘lose’ $10. The first loss doesn’t register but the second one does feel like a loss.

Here’s another example.

Let’s say you eye an Instant Pot (the ‘It’ appliance of today). You see it listed on sale, marked down from $99 to $59 – a $40 price drop at your local store. Of course, you are elated. You instantly drive to the store to buy your Instapot.

Let’s say you were also in the market for a new television. The model you’ve been eyeing has also dropped in price, marked down from $1,251 to $1,211. But this time you’re not excited by that price drop. It seems not significant enough, even though you’d, in theory, be ‘saving’ the same $40 as you did on in the Instant pot.

JND

Prof Thaler describes this phenomenon as ‘JND’ – a just noticeable difference.

JND is not an absolute amount but is proportional to the original value. When people find the JND, they are compelled to respond or act.

In the examples above:

• The $40 drop was a JND that compelled you to drive to the store to purchase the InstantPot.
• The $10 loss was a JND in a wallet that only had $10 to start with, causing you to wonder what happened to the money.
• Your weight gain was a JND to the person who saw you at the grocery store such that she felt compelled to gossip about it right away.

Why you need to worry about JND

Marketing geniuses have used JND quite cleverly. Unfortunately, if you’re not careful, you foot the bill for their genius. That's because they understand they're marketing to humans, not econs.

Here’s what JND means in the marketplace. A seller can potentially increase the price of a product without you noticing it, as long as the price increase is under the radar of a JND.

If you’re committed to buying a Tesla Model 3 and the price changes from $31,208 to $31,601, it probably is not going to be a JND. Therefore, your buying decision is likely to not change, although the price difference is almost $400.

Now, at the same time, if the espresso coffee machine you wanted to buy doubled in price from $300 to $600, you are likely to completely walk away from the sale. $300, in this case, is not just a JND, but an HND (Heck of a noticeable difference – this is my attempt at economic theory and my invented term, so please don’t google it).

In absolute terms, you may have been better off (by $100) in buying the coffee machine and holding off on the Tesla given the price changes. But that seems silly, doesn’t it?

We understand money is fungible. A dollar is a dollar is a dollar. But our actions belie our understanding of the fungibility principle. Because, we are humans, not econs.

Concept 3: Anchoring Effect

Another key theory that could spell doom for us is the ‘Anchoring’ effect.

Nobel Prize-winning psychologist Daniel Kahneman explains the Anchoring effect in his seminal book, ‘Thinking fast, thinking slow’.

The theory suggests that you can guide or nudge people’s response to a situation by providing ‘anchors’.

Mr. Smith and his house

For instance, I could ask you one of two open-ended questions.

• Can you guess the number of years the recently deceased Mr. Smith, lived in this house?

Yes, I’m asking you this question assuming you don’t know Mr. Smith or that he recently passed away or that he even existed.

It is a weird question. Even by my standards. But, go ahead, answer the question. What’s your guess?

Now, let me rephrase this question.

• The neighborhood Mr. Smith lived in has been around for a long time. Some of the homes were built 80 years ago. Can you guess the number of years the recently deceased Mr. Smith, lived in this house?

In theory, you still don’t know anything about Mr. Smith or the house. But I threw a vague fact in there and that distorted your thinking.

The age of the neighborhood, the fact that Mr. Smith died are all anchors – information simply thrown out there, that may or may not be relevant to the question posed. The anchors create the impression that Mr. Smith may have been an old person who probably lived in the house for a long time, say 50 years plus.

But the opposite may be true too. Mr. Smith could have been in his 20s, may have passed away in an accident. He could have bought the property a year ago to renovate and sell.

Your guess is as good as mine. Because I don’t know anything about Mr. Smith or the house either. Here’s the point though:

Our brains have trouble disregarding anchors in the decision-making process. Because we are humans, not econs.

Impact of Anchoring

Anchors interfere with the decision-making process even when we think they don’t.

Our brains are wired for us to consider these anchors, regardless of whether they are relevant or not, regardless of whether we think they’re taken into account in the decision-making process.

Take another example. Let’s say you are about to donate online and the donation form shows up.