New theory attempts to answer why humans don’t always make the best decisions

TROY, N.Y. — It’s common for people to make a decision they later regret. Mistakes and errors in judgment happen to everyone, and no one has the benefit of hindsight in the moment. Now, a new economic decision-making theory from Mina Mahmoudi, a lecturer in the Department of Economics at Rensselaer Polytechnic Institute, suggests a new explanation as to why humans so often tend to go with the adequate choice instead of the optimal choice.

Dr. Mahmoudi’s theory focuses on relative thinking. She hypothesizes that people often use ratios while making a decision when they should really deal in absolutes. Conversely, the opposite may also be true. Many people may tend to think in terms of “all-or-nothing” when a more balanced approach would be advisable.

“Effectively solving some economic problems requires one to think in terms of differences while others require one to think in terms of ratios,” Dr. Mahmoudi says in a university release. “Because both types of thinking are necessary, it is reasonable to think people develop and apply both types. However, it is also reasonable to expect that people misapply the two types of thinking, especially when less experienced with the context.”

A sale is a sale — not matter how much you save?

For example, if given the choice between saving $5 on a $25 product or saving $5 on a $500 product, prior research shows that most people will opt to save on the lower cost ($25) item. Why? Well, most would argue $5 off of $25 is a pretty good deal because the ratio of cost to savings is higher.

Dr. Mahmoudi argues, however, that at the end of the fiscal day $5 saved is $5 saved – regardless of an item’s cost. According to her theory the perfect, or optimal, choice would be for the consumer to look at the absolute savings and work equally hard to save $5 on each product. Ideally, a shopper should solve this problem using differences, but many habitually make unreasonable decisions due to ratio thinking.

“Understanding how the cognitive and motivational characteristics of human beings and the operating procedures of organizations influence the working of economic systems is of critical importance,” Dr. Mahmoudi concludes. “Many economic behaviors such as imitation occur and many economic institutions like inventories exist because people cannot maximize or because markets are not in equilibrium. Our model provides an example of a behavior that occurs because people cannot maximize.”

Researchers say they can apply this new decision-making model to any number of behavioral economic experiments across the gambling industry, financial markets, and many others.

The study is published in the journal Review of Behavioral Economics.

Comments

  1. Humans tend to flow through the path of least resistance. Difficult decisions are often postponed or simply pushed aside. A glowing example is politics. Politicians have made a science out of taking the easy road.

  2. Hmm, I think there are some flaws in the analysis. If a person has $500 to spend and the choice is to save $5 on $500 purchase or $5 on a $25 then why wouldn’t they logically go for the $25 purchase? If they bought the $500 item they would have a $495 item and have $5 in cash. If they went with the $25 item the could have bought 20 of them, saved a $100 and sold the nineteen they didn’t need at $25 so they would have one $20 item and $575. I guess that is the difference between an academically trained economist and an entrepreneurial street hustler

  3. “For example, if given the choice between saving $5 on a $25 product or saving $5 on a $500 product, prior research shows that most people will opt to save on the lower cost ($25) item.”

    What does this statement mean? How does one choose to save on one item versus another item? Are these $25 and $500 products competing for the same consumer? If so, a more straightforward explanation exists for why people buy the $25 product. If not, it’s a peculiar scenario in which us readers are asked to believe that buyers would look at a $500 tablet and and a $25 board game, and affirmatively decide to buy the board game not because of its affordability or suitability, but because the sale is a higher ratio of the price. I can’t buy that.

  4. Gordo53 has a valid point, to add to this people will postpone the decision until they only have 1 left, not necessarily the optimum call.

  5. This is crazy, and there is either a large assumption (frequency of purchasing said items) that has not been reported in this article, or not being realized by Dr. Mahmoudi.

    If I am buying something for $25 it means I am probably (assumption) buying it many times over like Toilet Paper. And if I see a pack of TP for $25 with a $5 off deal, I am buying it right away, no thought necessary. Because that will save me money and I know I will use it and if I do not buy it now and save $5 next month when I have to buy it again that $5 off probably will not be there and I will have missed out on it. Also if next month there is even a better deal and it is $6 off I will buy it again and I will not be unhappy that last month I saved only $5 I will just be happy that now I have saved a total of $11 on TP!

    Versus if I am paying $500 for something I am probably (assumption) only buying it once, or maybe once every 5-10 years. Like a TV or a dishwasher or a chair or something like that. So I am MUCH more willing to delay buying this item until I find the best deal possible. And $5 off a $500 item that I will only buy a few times in my life is a horrible deal. I am willing to delay buying something for $500 until I find the deal that I will like even if next month there is a deal $5 better. Because I would rather have had the said item for the past month then the extra $5 the new deal is at. Meaning if I bought a love seat for $500 and there was a $50 off deal, and then next month the same love seat has a deal for $55 off I would still rather have had the love seat for this past month even though it cost me $5 extra. However, I would not be happy at all if I bought the love seat this month for $5 off and then next month it was on sale for $50 off… I would see if I could return it and buy a new one for the extra $45 off.

    Somebody needs to explain the starting assumptions. Also I doubt you can tell people you will only buy the $25 item once and have that solve the above problem. The fact is that $25 is not a ton of money, if I make a bad decision concerning $25 it will not be the end of the world, at least for most families in America. So frankly I do not care as much if I make the best possible decision about something that will have little impact on my life. On the other hand, if I mess up on a $500 purchase and lose it all, that is serious money. For many people you might be talking that now you cannot pay rent. Versus if I totally mess up on $25 that might mean I have to skip Starbucks this month. Meaning I am much more invested in making sure I make the correct decision on the $500 purchase, even if you tell me I will only buy each item once. I will think if I totally mess up on the $25 item who cares, I will skip Starbucks this month to fix my mistake. Versus maybe not being able to make rent…

    I think Dr. Mahmoudi is talking just numbers. But, the people she is asking are talking in life consequences, and the limited amount of time they have to make sure they make the best decision possible. Or another way of thinking about is that if you are making $10 an hour the $25 purchase is worth 2.5 hours of your life, were as $500 is worth 50 hours. For a purchase that is just 2.5 hours of my life I am not going to waste another 2.5 hours of my life making that small decision. But, 50 hours of my life is a weeks’ worth of my time… I will spend some energy making sure I make that decision correctly. Thinking of it like this would allow for changes in the person’s earning potential. Someone making $1,000 an hour is going to probably answer differently than someone making less than $1 an hour if you are just talking about $25 versus $500. If the question was based on how much of their life it took to make the purchase… you might get more similar answers.

    P.S. If you purchase the $25 item 20 times you will have spent $500, and saved $5 each time or a total of $100 saved. So maybe people are also instinctively making that calculation.

  6. One could make the case that this theory is an example of mental evaluation of differences or ratios…for example this theory has a different level of acceptance of vagueness and explanation of anything, and the ratio of completeness is low…

    Maybe flush this out more before dropping undeveloped or under developed concepts.

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