Misbehaving: The Making of Behavioral Economics

Written By James King

6 min read

Richard Thaler - Misbehaving: The Making of Behavioral Economics
behavioral economics

Misbehaving is a guided tour through the emergence of Behavioral Economics as a serious economic discipline, written by one of its most respected figures. The title relates to Thaler’s core theme: people do not act in the ultra rational way that traditional economic theory assumes. Instead, they ‘misbehave’ by making irrational decisions in predictable ways. This is the story of a sometimes vicious battle between traditional economists and the growing school of behavioral economists to which Thaler belongs, told in an understandable way with a good dose of humour thrown in as well.

Summary of main ideas

Perhaps the most important character in Misbehaving is not a person but an invented species. ‘Homo economicus’ - affectionately shortened to ‘Econ’ - is like a real human in every respect, except for being perfectly rational, self-interested and capable of making optimal decisions.

As Thaler puts it: “The purely economic man is indeed close to being a social moron. Economic theory has been much preoccupied with this rational fool.”

Economists have traditionally based their theories on the assumption that human beings are completely rational agents, compelling critics to coin the Econ term. As a graduate student in the 1970s Thaler began to keep a note of his regular observations of human behaviour differing substantially from the behaviour expected by economists.

One example. Early in his teaching career, Thaler set a particularly difficult exam for his students in order to separate the extremely capable from the rest. This led to an average score of 72 out of 100 and caused “uproar” among his students who complained the exam was too hard.

Because the score was graded on a curve, the average score did not actually affect the distribution of the grades, but this failed to appease the angry students. Thaler’s solution was to tweak the next exam to make the total number of available points 137 instead of 100. The next exam was even harder but, because the average score was 97, the students were happy.

If humans really were perfectly rational beings, then they should not have cared about the points available. And if humans didn’t behave rationally in the way that economists believed, could these theories be flawed?

Other people were asking the same questions. Throughout Misbehaving, Thaler introduces us to a stellar cast of Behavioral Economics thinkers including Daniel Kahneman (author of Thinking Fast and Slow), Amon Taversky (Kahneman’s long-time collaborator), Cass Sunstein (co-author of Nudge along with Thaler) and many more who led the fight against a powerful opposition in the form of traditional economists, wedded to their theories.

Thaler also introduces a series of concepts that demonstrate the difference between Econs and real humans. A few (but certainly not all) of these include:

Prospect Theory

Prospect Theory was formulated by Amos Tversky and Daniel Kahneman and is regarded as one of the founding pillars of Behavioral Economics. Designed to describe the behaviour of actual people, the theory demonstrates how individuals consider loss and gain in an asymmetrical way.

For example, consider options for gaining $100. For the first option, you are given $200 initially and then you lose $100. For the second option you just are just given $100. Econs would not care about which option happened to them because the ultimate ‘utility’ is the same in both cases. But, real people prefer the second option because they feel losses more strongly than gains.

For a good overview of Prospect Theory, check out this article on Investopedia.

The Endowment Effect

Coined by Thaler in 1980, the Endowment Effect can be seen as an extension of Prospect Theory because it builds on the concept of loss aversion. It also relates to the Mere Ownership Paradigm, which is based on the idea that people give higher valuations to items they own compared to valuations of the same items made by people who do not own them.

A real world application of the Endowment Effect can be seen in marketing, where tactics such as free trials and test drives are used to give potential customers a sense of ownership of a product or service that they don’t yet own.

This video gives a good short overview of the Endowment Effect using the famous example of an experiment in which a group of people were given a coffee mug and asked how much they would be willing to sell the mug for while taking another group of people, not giving them the same mug, but asking them how much they would be willing to pay for one. The results showed that the mug owners valued the mugs almost double compared to the non-owners’ valuations.

Transactional Utility

Transactional Utility is one of several Mental Accounting concepts introduced by Thaler in Misbehaving. It relates to the perceived value of getting a good deal based on the difference between what an individual pays and their reference price for the item.

This video provides a good example of Transactional Utility at work.

How this book can help you

Misbehaving is an ideal entry point for people who are interested in learning about Behavioral Economics. Thaler’s clear and humorous explanations make the subject matter accessible and relevant to real world scenarios. By structuring Misbehaving as an (almost) chronological history, Thaler does a great job of placing the emergence of Behavioral Economics into a wider context of a changing real and academic world.

More generally, I think that building an understanding of this topic is important because it relates to so many areas of life, from understanding our own tendencies to make bad or illogical decisions, through to how we can relate to and influence other people. It’s not always easy, and I’m sure there are concepts and ideas that I will need to revisit (and this is after having already read Thinking Fast and Slow twice!) but, as one Audible reviewer put it very succinctly, “this book made me smarter.”

Some good further reading/watching/listening

Watch Richard Thaler in conversation with Google’s Chief Economist Hal Varian.

As well as Thinking Fast and Slow, I also recommend reading Michael Lewis' The Undoing Project: A Friendship That Changed Our Minds which tells the story of the birth of Behavioral Economics through the prism of Daniel Kahneman and Amos Tversky's friendship and The Victory Lab: The Secret Science of Winning Campaigns by Sasha Issenberg, which takes you into the world of politics and shows the gradual impact of behavioral economics and data on the science of winning elections.

Where to get it

Get Misbehaving on Amazon.

Get the audiobook version of Misbehaving.

About the author

Richard Thaler is an American theorist in Behavioral Economics. In 2017, he was awarded the Nobel Memorial Prize in Economic Sciences and in 2018, he was elected a member in the National Academy of Sciences. He has published six books including Nudge, which he co-authored with Cass Sunstein.

Published by

W. W. Norton & Company

Publication Date:

May 7, 2015

Building a reading habit pdf

Want to Build an
Effective Reading Habit?

Subscribe to our sporadic newsletter
and we will send you a pdf guide:
How to Build an Effective
Reading Habit in 2021

PaperBackTravels © 2021

Paperback Travels is an Amazon Associate. When you buy through links on our site, we may earn a commission through qualifying purchases.