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.


Josh Treacher said...

This is an extremely interesting observation. What doesn't seem to be addressed however includes the moral implications or the dangers ofusing such decision making strategies.

One could argue that tricking an individual, firm or multiple of both is immoral because it is unnaturally influencing them to make a decision they would not willingly have made otherwise. I agree with the notion that this strategy could be effectively implemented in solving such collective action problems as those present in delivering public goods. However, conformity is used equally in the realms of politics and culture, and this means that personal or large-scale influences could affect the intention behind using a conformity-inducing strategy. In Nazi Germany, Hitler used his anti-Jewish rhetoric to get the whole country to boycott Jewish businesses. Excuse me for jumping to the extreme, but is may be the only way to illustrate the potential dangers of living in a society where we do not have full, complete information about the public and private economy. Without this information we may be successfully directed into making better and/or rational economic decisions, it comes at the expense of our free will to make seemingly irrational decisions.

Despite this I agree with the point you are advancing because this isn’t to say that people are not already doing this for self-interested purposes. Applying conformity as a strategy to enhance the supply of public goods may be a very effective and beneficial strategy, provided that it is done for the right reasons.

Josh T.

Feriha Ibriyamova said...

Very nice post. Just one think I might have missed is how is Solomon Asch's experiment related to economics. As I see it, it has contributed a lot to psychology and it explains a lot about group behaviour but it seems more relevant for politics as the Minnesota experiment only proves that you can take advantage of the public and pass legislations and policies however when it comes to making them it more of a principle agent problem (problem if the policies are bad) lobbyist take advantage of their bargaining power and information asymmetry.
Whereas for the 2008 crisis it was fueled by the fact that people didn't have the whole information as well and came to wrong conclusions adding to the problem, however, big companies like the Lehman brothers failed and others like Goldman and Sacks didn't which the Solomon Asch can't explain the whole problem the big companies had was they were so invested they had no way out other than speculate and hope they will be able to get out of it but some miscalculated and bought more assets and borrowed money to do so and others were able to predict the crash and pulled out on time and got about with less damage.
But I suppose the problem with this experiment is that it is a lab experiment people might have done what they did to avoid conflict and confrontation in both cases you mention and the results cannot be generalised to the real-world.

Feriha I.

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