Economics

The Credit Crunch was partially characterised by people who didn't want to cut their losses and sell, refusing to show a loss. Is this sort of behaviour part of a thought-out plan, or is it instinct?

It turns out that economics "work" in a way that is predictable and hard-wired into our brains. In an experiment where monkeys were taught to use money, the monkeys made decisions that directly reflected decisions that contributed to the Credit Crunch.

Monkeys were taught to use coins in order to buy grapes from laboratory "salesmen".

In the first experiment the monkeys could choose between two options: one salesman sometimes doubled the number of grapes after the sale was made, and sometimes he didn't; the other salesman always added one grape after the sale was made. The second salesman therefore represented a *safe* option with a certain increase in product, while the first salesman represented a *risky* option. Most monkeys bought from the *safe* salesman, preferring a sure increase in the product they bought.

In the second experiment the monkeys had two different choices: one salesman would always sell two grapes, but remove one before handing the grapes over to the monkeys; the other salesman started with three grapes, and either removed two, or none. The first salesman again represented a *safe* option as he always did the same thing, while the second salesman represented a *risky* option as he sometimes handed over less grapes than could be bought from his competitor. Most monkeys bought from the *risky* salesman here, preferring the choice of potentially getting a lot more grapes than they would get from salesman number one.

In the first experiment the monkeys had, in effect, a small amount of money which they could increase by a defined amount (always getting one extra grape), or by an unsure amount (getting no extra grapes, or two extra grapes). Monkeys chose to increase their money by a defined amount.

In the second experiment monkeys had, in effect, a large amount of money which they could have decreased by a defined amount (always getting one less grape than they bought), or by an unsure amount (getting two less grapes than they bought, or not losing any grapes at all). Monkeys chose to avoid the certain loss of money here, and took a risk by buying from the *risky* salesman.

In the Credit Crunch (and in economics in general!) the behaviour of people follow the model highlighted by the monkeys here: when people start off with a small amount of money, they're less likely to take risks with it, rather choosing to increase their money by a defined amount. When people start off with a very large amount of money, they don't want to lose any of it, so they're more likely to take risks with it. They do this even when it is obvious that they might make a massive loss. This is why people are reluctant to sell falling stock or put their houses on the market when prices are dropping. People hate the idea of losing what they have, almost regardless of the implications.

The impulses that lead us are evident in our monkey cousins. This implies that our decision-making skills, and our relationship with risk-taking, was formed many millions of years ago. We have failed to "evolve" out of this particular way of acting and reacting, but this isn't unusual. We also have a great love of fat and sugar, even though over-consumption of these foods lead sto health problems. The one thing that we *do* have is the intellectual capacity to consider situations and make reasoned and considered decisions. Therefore we aren't hostages to our natural instincts.

The research cited in this post was done by Laurie Santos at Yale University. For a 20-minute run-down on her research, be sure to watch her captivating and engaging lecture at http://www.ted.com/talks/laurie_santos.html.