Richard Thaler: Economics Meets Psychology

How Richard Thaler brought psychology into economics, developed ideas like mental accounting, and helped design nudges that raise savings.

Richard Thaler won the Nobel prize in 2017 for his contributions to behavioural economics. For years, his ideas were seen as odd by mainstream economists. Today, they are central to economics and public policy.

The anomalies

In the 1980s, Thaler wrote a series of columns called Anomalies, documenting behaviour that standard economics couldn’t explain, such as people refusing profitable trades or valuing things more once they own them.

Key ideas

Mental accounting: people treat money differently depending on its source or intended use, such as spending a tax refund freely while being careful with salary.
The endowment effect: people value things more once they own them. In experiments, people given a mug demanded far more to sell it than others would pay to buy it.
Self-control: people have “planner” and “doer” selves, explaining procrastination and undersaving.
Fairness: people care about fairness and will punish unfair behaviour, even at a cost to themselves.

Nudges

With legal scholar Cass Sunstein, Thaler wrote Nudge (2008), arguing that choice architecture - how choices are presented - can guide people toward better decisions while leaving them free to choose. They called this libertarian paternalism.

Governments worldwide set up nudge units to apply these ideas.

Save More Tomorrow

With Shlomo Benartzi, Thaler designed Save More Tomorrow, where employees commit in advance to increase their retirement savings rate whenever they get a pay rise. Since the increase comes with a raise, take-home pay doesn’t fall. Companies that adopted it saw large increases in savings rates.

Pop culture

Thaler appeared in the film The Big Short (2015), explaining the “hot hand” fallacy alongside a celebrity.

The pay rise commitment

An employee agrees that each time she gets a raise, 3 percent more of her salary will go into her retirement fund. She barely notices the change, since her take-home pay still rises. After a few years, her savings rate has tripled.

Thinking nudges force people to choose

Nudges change how options are presented, but people remain free to choose differently.

Key takeaways

Thaler won the 2017 Nobel for behavioural economics.
He developed mental accounting, the endowment effect and self-control ideas.
With Sunstein, he popularised nudges and choice architecture.
Save More Tomorrow raised savings by linking increases to pay rises.