Behavioral Economics - Prof. Ranjan Banerjee ( IIM C )
Prof. Ranjan Banerjee is the founder of Renaissance and is currently heading the ship as its CEO. He did his B.Tech from IIT-B, MBA from IIM-C, & in 2010 completed his Ph.D from Carlson School, University of Minnesota. He is an ardent foodie and follows cricket religiously. He is always game for exploring new ideas.
When I talk to students and corporates about behavioural economics for the first time, they find it both cool and disturbing. Cool because the behavioural economics phenomena are interesting; and disturbing because they break a myth. What’s the myth that they break? The dominant theory that we have had about how people make decisions is that people are rational. When we say that people are rational,it kind of assumes that we know exactly what we are doing. But we have always known that in the real world, it is natural that human beings make mistakes.
Behavioural economics, put simply, is the science of how people make mistakes. Let me give you a simple example. Suppose I give you two choices for a new treatment for a disease. You are told that in the first case 200 people will definitely be saved by the treatment. In the second case, there is a one- third probability that 600 people will be saved and there is a two third probability that nobody will be saved. In this case, most people will take the sure option. Now, let’s suppose I give you a second choice in which I tell you that the first option is that 400 people will die for sure. In the second choice I tell you there is a two-third probability that 600 people will die but there is a one-third probability that nobody will die. Interestingly, when it is framed in a positive manner, everybody would want to save 200 people. However, when it is framed negatively, everybody gets scared at the thought of 400 people dying.
This brings us to the first and primary tenet of behavioural economics. The way people make decisions depend on the way those decisions are framed. You can observe this in many situations. When we used to come home from school with our marks-sheet, the first question was about the highest score. There is always a frame of reference; and decisions are judged based on whether they are gain or loss making against that frame of reference. The interesting insight here is that just by changing that frame of reference; you can change people’s decisions. So what we realise is that reference points can be manipulated.
Now let’s say I’m a marketer. What can I do with this insight? Let me tell you about a simple experiment on a bunch of graduate students. They were given two choices. The first choice was an online subscription to The Economist at 58. Since graduate students like to save money; they chose the online option. Another group of graduate students were given three options. First option same as before 58, third option print plus online 125. Students who had their social security number between 80 and 100 guessed 26. This figure was not from the company or from Mr. Jobs. This was what trade press was saying. And then at the I-pad launch, Steve Jobs says, “what’s the price going to be?” And he puts up a slide with 999 appears. Now why 999? This to me is a marketing application of anchoring. The only purpose of 999 was to introduce 499. Therefore the MIT students and the consumers of the I-Pad both are subject to the anchoring effect.
Ok so here is my parting shout. Here is a question for you. How many animals did Moses take on the Ark? Think carefully… well here’s the answer. Moses didn’t take any animals on the arch, Noah did.
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