Daniel McFadden: Understanding better how people really make choices

The way our brains work is key to understanding how consumers really make choices, argues Nobel Laureate Daniel McFadden. Some consumers suffer from “agoraphobia” or a fear of markets according to new research presented by Nobel laureate Daniel McFadden that throws doubt on the classical idea that people are driven by relentless and consistent pursuit of self-interest to maximise their well-being. Professor McFadden entitled his paper The New Science of Pleasure, to purposefully play on a phrase coined by Anglo-Irish political economist Francis Edgeworth some 130 years ago. He told the audience of young economists and fellow laureates at the 5th Lindau Meeting on Economic Sciences on 22 August that new studies of consumer behaviour that drew on psychology, sociology, biology and neurology gave economists a deeper understanding of how consumers made choices. Rational analysis says that we should relish choice and the opportunities offered by markets. “Yet we are in fact challenged by choice and we use all kinds of ways such as procrastination to avoid having to make choices. One of the reasons is that there are risks associated with making choices,” he said.
Daniel McFadden at #LindauEcon14. Photo: R.Schultes/Lindau Nobel Laureate Meetings

Daniel McFadden at #LindauEcon14. Photo: R.Schultes/Lindau Nobel Laureate Meetings

Market agoraphobia He highlighted an experiment he carried out some time ago at his university where half of the students were given a chit saying they were entitled to a pencil and half did not. The two groups could trade as buyers and sellers. While traditional economic theory said the market should clear with half the pencils sold at close to a median value. In fact less than a fifth were traded. “One answer is that people have agoraphobia – they don’t like markets and that influences resource allocation,” he said. He said that there was evidence that people were far more rational when decisions that were immediate and had major implications compared with choices that were remote or minor. “That’s when things fall apart.” He said that sociology, psychology and brain science had thrown new light on this issue. Social networks are important because they are sources of information and social approval or disapproval is very important in guiding people’s choices. “You get market equilibriums that are markedly different across different social network so there is no unique equilibrium,” he said. Cognitive psychologists such as fellow laureate Daniel Kahneman have done decades of research into area and highlighted patterns of behaviour that influence how we make decisions. Happiness of pursuit Brain science – or what economists called neuroeconomics – is perhaps the most live area. In particular it has identified reward structures and neurotransmitters in the brain, and the impact of choice problems on the brain in the presence of experimental treatments. He said:
“The hedonic treadmill we are on can be characterised as not the pursuit of happiness but the happiness of pursuit. That’s what that people really care about.”
Interestingly pleasure and pain are in different circuitries in the brain while decisions involving gains or losses take place in separate parts of the brain. The net result is that there is therefore a physiological basis for the cognitive anomalies such as loss aversion, the endowment effect and hyperbolic discounting that psychologists have identified. The classical economic of choice is therefore far too simple as it does not capture what goes on in people’s brain when they make choices. “It is also much too static to capture the sensitivity and dynamics of the process,” he said. However he said that welfare economists based on neurological measures of utility and brain functioning was coming. “But we are not there yet. Wait for it – but even better get involved in the types of research and the bridge between economics and other disciplines and play a role in making this come true.”   Here is the full Video of McFadden’s lecture:
Phil Thornton

About Phil Thornton

Phil Thornton is lead consultant at Clarity Economics, a consultancy and freelance writing service he set up after a 15-year career as a newspaper journalist. Clarity Economics (www.clarityeconomics.com) looks at all areas of business and economics including macroeconomics, world trade, financial markets, fiscal policy, and tax and regulation. He has written for a range of publications including The Wall Street Journal, The Independent, Independent on Sunday, The Guardian, The Times, The Daily Telegraph, Financial Director, Emerging Markets, City AM and PM-Select. He writes a regular economics column for Procurement Leaders. Recent projects include a series of reports looking at the position of ethnic minority groups within the UK workforce for Business in the Community; drawing up proposals for reform of the EU Budget for Business for a New Europe; and an examination of lessons learned 20 years after Big Bang for The Centre for the Study of Financial Innovation. In 2010 he won the Feature Journalist of the Year award in the WorkWorld Media Awards. In 2007 he won the title of Print Journalist of the Year in the same awards. Until 2007 he was Economics Correspondent at The Independent newspaper of London, a post he held for eight years.

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10 comments on “Daniel McFadden: Understanding better how people really make choices

  • Noni Mausa says:

    I don’t know what platform this video is running on, but my goodness it is slow to load. My iPad wasnt keeping up, so I am on my desktop now and not getting any better speed. but I will pause it for a while and let it preload, because I really want to hear this.


  • Hi. Had no problems in playing the video- very interesting and relevant especially the message to the British government. The text has some errors ie should say ‘the pursuit of happiness’ but the ‘of’ is missing. Makes it less pleasurable to read.

  • Is this some strange experiment on choosing not to use a website??? Your embedded videos do not load, pointless, which makes your article pointless – your logo says inspire, educate, connect -so try using a real video serve that actually connects so you can inspire and educate… Like YouTube or Vimeo. Not intelligent.

  • Declan O'Byrne says:

    The idea that people should invariably be attracted to choice completely misses markets informal cartels, whereby consumers are offered a “choice” between very similar services eg utilities or products eg granulated coffee, milk, a house according to one’s mortgage potential.

    McFaddens theory might encapsulated as
    Ho: consumers are not interested in choice
    Ha: consumers are interested in making choices
    E.g Ho: consumer are not interested in choosing between 2 mortgages irrespective of their features
    Ha: consumers are interested in choosing between2 mortgages which are completely alike eg both 3.5%, with 10000 early redemption fee
    I would position an alternative Ha
    aHa: consumers are interested in making choices which with material differences
    aHa: consumers are disinterested in making a choice between 2 mortgages with no difference in conditions or interest rates,but are interested in choosing between a slightly higher rate and ability to pay more monthly without penatly charges or picking a lower rate mortgage with penalty for finishing the mortgage early.

    It’s really about material rather illusory choice. This something marketeers seem to wholly overlook and for certain percentage of population, the star and as partner holding the box of commodity xyz may work. For others it bores them. Such a state explains the increasing disillusionment with of “representative” and “democracy” sequentially joined. To expand, a picture of an apple will not satisfy the hungry boy.
    D. O’Byrne

  • Declan O'Byrne says:

    There,s no edit, so I apologize for the typos.

    An alternative aHa (aaHa) the market is self -limited to the degree the consumer is exposured to illusory choices

  • Phil Thornton says:

    You make good points. AS the talk was three years, both economic thinking and Prof McFadden’z analysis have doubtless moved on. I would definitely take the point about the growing disillusionment with illusory rather than real choice. That may indeed inform the way people voted in the Brexit and US Presidential polls.

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