25 Nov 2015

Social Influences on Decision Making

Lisa writes*

In the 1950’s Solomon Asch conducted a series of experiments to demonstrate the power of conformity in groups. A group of participants were placed in a room together where they were shown a line; they then had to match this line to one of the three other lines presented to them. Each participant, in turn, would then verbally announce which was the matching line. However, all but one of the participants were in on the experiment – they were told how they should respond. The idea was to see whether the participant, who was not in on the act, would change his or her answer to conform to the rest of the group’s responses. The results showed that participants would change their answer in order to conform to the incorrect group answer approximately 1/3 of the time.

So why do people discredit the evidence at hand? 1) If everyone else is saying an answer that seems to be wrong then they may have more information than me about the task at hand. 2) I do not want to face disapproval from the group so I will conform to what everyone else is saying.

These findings have been used in the fields of behavioral economics and microeconomics to analyze how individuals can be influenced or “nudged” into making certain or better economic decisions.

Officials in Minnesota orchestrated an experiment in order to change individual behavior on tax compliance. Taxpayers were given four different types of information when completing tax forms:
  1. Their tax would be going towards education, police protection or fire protection.
  2. They were threatened with the risks of punishment for noncompliance.
  3. They were given information on how to get help with completing tax forms.
  4. They were told “90% of Minnesotans already complied, in full, with their obligations under tax law”.
Remarkably the last of these interferences had the most profound impact on tax compliance. Knowing that most people complied with the tax law influenced these taxpayers’ decision-making in order to conform with the majority of the population.

In addition, such “following the herd” behavior can have a profound impact on the economy. It is believed to have “played a key role in producing the recent speculative boom and resulting financial crisis of 2008”. Robert Schiller emphasizes the role of such behavior in volatile markets. A speculative bubble, he explains, is "a situation in which news of price increases spurs investor enthusiasm, which spreads by psychological contagion from person to person, in the process amplifying stories that might justify the price increase." Public knowledge begins to spiral, demand rises and market prices start to escalate. Eventually the bubble pops.

Bottom Line: People tend to make decisions that align with what everyone around them is doing. On the positive side: policy makers can use such knowledge to nudge people into making better economic choices. On the negative side: such behavior can cause speculative fervor that overshadows any economic fundamentals.

* Please comment on these posts from my microeconomics students, to help them with unclear analysis, other perspectives, data sources, etc.