The CEO Game

A field that is closely related to behavioral economics and aiding its development is Neuroeconomics. Neuroeconomics uses the insights and methodologies of neuroscience, the study of the brain, in order to deepen our understanding of economics. Neuroscience has both been able to augment some of the traditional assumptions of classical economics (termed the “incremental approach”) and to force economics to completely rethink classical economic constructs (termed the “radical approach”). Classical economics evolved based on a system of revealed preferences — the idea that people’s preferences can indicated correctly through their actions, such as through their purchases. Now that a neuroscience technique allows measurement of actual thoughts and feelings, the link between feelings and actions is being broken down.

Understanding The Brain.

What neuroscience doing, perhaps most importantly, is illuminating the difference between controlled and automatic responses and between the affective and cognitive systems. Classical economics mostly deals with controlled responses and the cognitive system. It presumes that people always can and do fully take the time to weigh all of their options, think of all of the ramifications, and pick the option that maximizes their utility. Some responses, however, are automatic. People have little control over these processes and even very little introspective access. Therefore, the usual utility-maximizing behavior cannot apply. Furthermore, some responses, whether or not there are automatic, are drive by the affective system. This includes not only emotions, but also drives, such as arousal, pain, and craving.

What tools does Neuroeconomics employ? Firstly, Neuroeconomics employs neural imaging techniques, such as MRIs, PET scans, and EEGs. But the field has a number of other tools at its disposal, including single-neuron imaging (used only on animals, thus far), electrical brain stimulation (EBS), the examination of brain damage and its effect on humans, Transcranial magnetic stimulation (TMS), diffusion tensor imaging (DTI) and the monitoring of physiological indicators.

The use of neuroscience techniques to inform economics is Neuroeconomics. So what have these techniques told economists? Firstly, it challenges many of the basic constructs we now use, such as risk aversion and time preferences. For instance, classical economics assumes that people have consistent discount rates across different activities. However, neuroscience shows us that different parts of the brain are used when contemplating or doing different activities. Thus, the discounting involved overeating may be completely different than the discounting involved in properly storing your shoes. Secondly, brain scans suggest that people react similarly to the gain or loss of money as do the gain or loss of food. This implies that money itself has utility, as opposed to being an indirect measure of utility as something than can be used to obtain other things. Thirdly, the distinction in the brain between pleasure and motivation system shows that people do not always pursue the most that is that they want the most, which is a basic assumption of classical economic theory. This is just a sampling of the findings of neuroeconomics.

The implications of neuroeconomics are staggering. With the brain more accessible than ever before, assumptions that were made before economics could know how people thought have to be rethought. Though it is too early to tell exactly how and if economics will integrate this field, it is certainly promising to change the way many of us think.

Tamar.

The CEO Game.

Traditional microeconomics teaches us that we should make decisions on the margin. That is, we should ignore sunk costs. Sunk costs are costs we have already been incurred and cannot be recovered regardless of your next time. In order to optimize revenue, theory of the firm states that, in perfect competition, marginal revenue should be equal to marginal cost. That is, how much you earn for selling the last unit of a product should be how much it costs you to produce that product (in this perfect world, that would also be the price on every unit). This also applies for people and their utility. You should assess both costs and benefits on the margin, in the next time period, on the next purchase, without thinking of everything that came before.

Logic In, Emotions Out.

Most of us, of course, don’t do this. How many times have you sat through a movie you hated because you paid for the ticket already? How many times have you waited for the subway an extra 20 minutes instead of just walking because you have already waited for 20 minutes? And how many times you have eaten that last slice of pie even though you were really incredibly full because you already heated up the whole thing and you didn’t want to throw it away? Enough times, I am sure, that you are aware of the phenomenon of, at the end of the movie, wait, or pie, being incredibly bored, late, or nauseous, and wondering why you just did that.

The reason you just did whatever irrational behavior it was that I just described (or a host of others) is that, unfortunately, you’re human. And that, as always, is the lesson from behavioral economics. Humans aren’t irrational! So why treat them that way? Now we come back to our good friend prospect theory, which was mentioned in the first article I wrote about behavioral economics. In addition to valuable insights on reference points, prospect theory states that people are inherently loss averse. Not only that, but they did to weigh losses twice as heavily as gains — that is, a loss of $1 is twice as painful as a gain of $1. The combination of a non-neutral reference point and loss aversion is what leads to irrational behavior.

Once you have decided to see the movie, wait for the subway, or eat that piece of pie, your reference point account for your doing those things. That is your neutral position. Not achieving these goals is a loss. This sort of mental accounting, as it is called, commits you to decisions that are less than ideal.

A good businessman, either online in a serious game such as The CEO Game or in real life, doesn’t let a misplaced sense of regret and loss stop him from making proper economic decisions. Recognize when you’re including sunk costs in your decision-making and put an end to it. Live life on the edge, or margin. You’ll be happier, and wealthier, for it.

Tamar.

The CEO Game.

The insights of behavioral economics help us explain behavior that is familiar, and frustrating, to us all. Last week we posted an entry about how to increase productivity in the workplace. Today, I will discuss the heart of the problem brought up in that entry — why do we procrastinate to begin with? Traditional economics assumes that we are all rational actors; that is, we always act to increase our utility. But anyone who has put off a major project until the night before it was due only to have to spend a painful night scrambling to create a worse product than you are capable of knows this isn’t true. Same goes for other hurtful behavior, such as smoking or not working out.

procrastinate. Just Do It.

In a nutshell, behavioral economists have found we put most value on what our current self is doing. You, right, now, are the most important factor when making any decision. Current costs and benefits are weighed most heavily; future costs and benefits are considered less. That means that we put off doing unpleasant things because we overweight the pain it will cost us in the first period. We assume that in the next period, tomorrow, usually, the pain will be less and therefore we will do whatever it is we have to do. Lo and behold, when the next day comes around, we now overweight the cost of performing the task today. And so we wait until tomorrow, when we think it will cost us less. And so on, until there are no time periods left, and you’re up all night drinking Amp and cursing.

We also overweight current pleasure. This is part of why we procrastinate — we think that the fun we will have today watching TV instead of programming will be so much greater than the pleasure the same program will give us the next day. Turns out that the next day “It’s Always Sunny in Philadelphia” is just as funny as it was the day before.

So what is the relevance of present-biased preferences to the aspiring CEO? Winners don’t put off for tomorrow what can be done today. Whether in real life, or in a management simulation such as the CEO Game, time is money. But how can you prevent something that research finds, over and over again, is part of how we, as irrational actors, function? Firstly, knowing is half the battle. Being aware of the implicit decisions you make when putting something off and making real, hard decisions about what things will actually make you happier can help. Secondly, you can use something called a commitment device. A commitment device is anything that increases the cost of procrastination. One effective way is to have to pay out to a third party when you procrastinate — stickk.com helps you create your own commitment contracts. For instance, you can be forced to donate $10 to your least-favorite charity every day you put off an assignment. Try these tips at work or in a serious game and thank the behavioral economists for the success that will come!

Tamar.

The CEO Game.

The burgeoning field of behavioral economics has many insights for the aspiring CEO. In a series of posts, I will bring up a few of the key concepts of behavioral economics and discuss how they apply to a would-be business tycoon.

Does Fairness Matter?

Reference-dependent preferences, an idea first pioneered by Kahneman and Tversky in 1979, are a cornerstone of behavioral economics. The main idea is people’s utility is affected by gains and losses coded from a neutral reference point, rather than by final asset positions. This means that people don’t feel like they’ve won or lost based on how much money they’ve netted alone, but based on how much money they’ve netted relative to a specific reference point.

A simple example of a reference point is the expected value of a wager — if the expected value of a bet is $100, but a person ends up winning only $20, they will feel like they have lost money, even though, overall, they have gained. There are many other possibilities for a reference point. Expectations are another key example of a reference point. If someone expects a raise of $1000 every year, because he has been getting it year after year, a raise of only $800 will not feel like a gain, but instead as a loss of $200.

So what effect does all of this have on our CEO? One of the main implications involves wages. Every CEO needs to understand how to motivate his employees to work, while still earning a profit. A crucial part of how to do this is by choosing the right wage. Reference points can embody notions of fairness. People expect to have their hard work reciprocated through fitting wages. When the wage changes from the wage that is considered “fair”, even if the CEO believes that it is the correct new wage, employees may react with anger and shirking. This is especially true if the management is perceived to be increasing its own share at the expense of its workers.

For the savvy CEO, both in the real world and in a business simulation such as the CEO Game, it makes one must be aware of the way wage decisions are perceived. Employee morale is key, and the CEO must not dampen it, through decisions about wages, raises, and bonuses that violate employee expectations or their sense of fairness. In these tough economic times, especially, when cut backs are necessary, some firms are finding it better to cut all workers’ hours equally and keep all of them than to fire old workers in order to hire new, cheaper ones. There are many other creative responses to the current recession that incorporate the findings of behavioral economists.

Tamar.

The CEO Game.

What is Behavioral Economics?

Logically wrong.

Behavioral economics is an academic field combining the departments of economics and psychology, providing useful implementation of studies done in behavioral science, in order to understand better the subject of decision-making at the economic field, and how it affects the economy: prices, investments yield, resource allocation etc.

The discipline deals mainly in rationalism or irrationality of market agents and public trends for decisions making.
Models of behavioral economics combine insights from the field of psychology with the theory of neo-classic economic.

Ok, that was a bit long and confusing.
So what is behavioral economics is all about?
It means that economics is not something you can measure in logical terms. The main key factor for eco-changes is humans, and those creatures as you already know, aren’t that rational.

If you study the cognitive and emotional factors, on a certain group, you may find explanations for some of the groups economic decisions.
One of the most important issues are the effect on market decisions and public choice.

Why we need it?
because we humans act irrational!

• Why gambles in casino are keep gambling although they know they’re gonna lost all their money?
• Why people always say they need to save money for retirement, start exercise, stop smoking, keep on balanced nutrition- and still do nothing?
• Why victims, who have been treated improperly, demand revenge, although it damages their interests?

All those (and many more – I can go for hours), harms the ‘economic person’ model, which has been the base of the classic and new-classic economics for hundreds of years.
The ‘economic person’ take rational and logical decisions, motivated by personal interests, after considering the cost-benefit and try to maximize his profits.
The ‘economic person’ is a wise, reasonable, selfish and analytic person, showing perfect self-control, and act in order to achieve his future goals. He is not moved aside by his mental or physical states.
This man is the base of all the economics theories and models for the past hundred years.
There’s one problem – He does not exists!

While dealing with real people, you find out different types of irrational behaviors.
Some actually damages the person himself, some showing altruist behavior and far from the one’s interests.
The bottom line: psychology takes huge part on the process of decisions making, revealing the conflict between logics and passions.

People, like animals, have basic tension between provide themselves immediate satisfactions, and patiently waiting for future satisfactions.
They want it here and now, and also wish to think about tomorrow.

In general, people act irrational when they are underestimating in the value of the future.
They (humans) spend too much value and effort for things we want to do right now, on the expanse of the other good thing we can do in the future.

And still- marketing is everything!

It has been shown that the wisdom of marketing is the base for motivating the mass and the crowd to change their way of thinking and choose one product over the others.
Marketing is a key factor in which the economic person reaches all the irrational ones, and affects them to do what is right, diverse from the immediate satisfaction desired.

Marketing, by the orientation of behavioral economics, must take into consideration the population it’s aiming too.
Geo-location, age, education, standards, latest trends and culture are one of the many things it should consider.

Is it also relevant for the CEO Game? Of Course!
One of the most important roles the CEO need to be very close to is the Marketing department. It must be creative, smart, and targeted.
The difference between become the hottest trend and be another shelf product as many others, is by taking the public heuristics into consideration.
Learn the area, learn your potential consumers, feel the market and think how to become outstanding (original rather than normal).
Develop a marketing plan and sale your products as they are the best thing the community could ask for, be aggressive but gentle, think big and give credit for your buyers.

And the most important, always remember that humans are irrational. You can’t predict the future.

Cheer’s!

Nimrod

The CEO Game.