Human irrationality about money

I'm a big fan of Financial Jesus and pop in for entertaining financial news. Below is an intriguing article I found and wanted to share it with you.

Bobby

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I am a big fan of behavioral economics which tries to explain why people act the way they do.
Here are 3 interesting experiments that scientists have made in order to get a better insight into how people relate to money.

 
The Ultimatum Game
You are given 100 dollars. You need to decide how to split this money between yourself and another person taking part of the experiment. If the other person accepts the amount that you will give him – you will both get to keep your share of the money. If the other person declines – neither of you get the money.
This experiment is set up in order to reveal whether mankind is rational (as the economic theory suggests) or not.
A rational person would accept any amount offered because he or she knows that when he doesn’t accept the amount that is offered to him – he gets nothing. In other words if the first person(A) taking part of the experiment suggests to the second person(B) that they should split the money $99 to A and $1 to B – the second person should accept. Rationally looking it is better to get 1 dollar than nothing.

What really happens?Proposals to accept less than 30 dollars are usually rejected. The reason? According to our judgment the proposal is not fair. If you are offered a small amount of money while the other person gets a lot more (that comes from potentially your money) – you’ll have a feeling of injustice and would rather not get money than to get a small amount and feel bad afterwards.


Perceived value of money
The following is a thought experiment. Would you rather earn 100 000 dollars when everyone around you makes $50 000 or would you rather make $200 000 when everyone around you makes $400 000. The only rule you have to keep in mind is that the cost of living and goods stays the same. Which option will most people choose? A rational person would choose the second option, where he makes more money but less than people around him. That way he will have twice as much to spend. In reality most people choose the first option – being richer than other people. Some scientist think this experiment demonstrates the irrationality of man. I disagree. This experiment clearly shows that social rank is far more important to people than the amount of money they have. If one can choose between more money than your friends vs. less money than your friends – it is a rational decision to choose the first option (even when the total amount of money is less than in the second option). In this experiment people make an irrational money decision but a rational “people decision”. The latter outweighs the first.


The Line Experiment
The first person is standing in a line. When he gets to the counter he is congratulated on being the 1 millionth customer and as a gift gets 100 dollars. A second person is standing in a line at a different place. The man in front of him is congratulated for being the 1 millionth customer and wins 1000 dollars. The second person wins $150 for being the 1 million and first person. Which would you rather be? Surprisingly most people would choose the first option – getting the $100. Money wise this is a bad decision – you lose 50 bucks. The reason most people would rather lose the $50 is because they don’t want to feel the regret of not being the millionth person themselves and winning $1000.


What do these experiments show
These experiments show us, that just like in other things people can at times be irrational when it comes to their money. There are situations in life that are more important than money and economists need to understand this. When talking about economy (and the stock market), we should realize that economy consists of ordinary people who at times make financial decisions that are money wise bad for them.

Source: www.financialjesus.com

Should YOU have a say? Iceland Debt Referendum

Are the Icelanders right in their viewpoint of asking why should they be penalised (through taxes) for the excesses of a few banks?

The Americans and British have already printed oceans of money to bail out the banks (NOT the people) and we as tax payers will have to pay to keep the untrustworthy rich in their jobs, businesses (banks) and bonuses! The untrustworthy being those that live off other people's money regardless of how incompetent they are at providing the service they promise ie. bankers and government workers.
Are you asking yourself these questions too... Is that really what capitalism is about these days?
Is it really fair that we don't get to vote on what happens to us?
Is it time for a revolution yet or will people wait until the banks and government walk into their homes, eat their food and then kick them out!?

Bobby

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Many Icelanders are demanding a "reasonable" agreemen

Iceland has held a referendum on plans to repay the UK and the Netherlands debts owed from the collapse of Icesave bank.
Despite overwhelming opposition to the proposal, the country faces years of financial pain.
What was the referendum about?
Iceland's 320,000 citizens voted on whether their government should repay Britain and the Netherlands more than 3.8bn euros (£3.4bn) - equivalent to each person contributing 99 euros a month for eight years.
Britain and the Netherlands say they are due the money following Iceland's financial meltdown in 2008. But Icelanders say the terms of the repayment are too onerous and rejected the package in its current form.
The collapse of three of Iceland's biggest banks overwhelmed the country's deposit-insurance scheme.
Some 340,000 British and Dutch depositors in the Icesave online bank (owned by Landsbanki) had to be bailed out by their domestic compensation scheme.
Now these two countries want their money back from Reykjavik.
At stake is nothing less than Iceland's ability to restore its economic credibility in the eyes of the world
According to Dragana Ignjatovic, analyst at IHS Global Insight: "In order for Iceland to even hope to rebuild its battered reputation, a compensation deal needs to be reached."
Speaking to the BBC, Chancellor Alistair Darling said the UK would get its money back, if not for many years.
"It's not a matter of whether the sum should be paid. There is no question we will get the money back but what I am prepared to do is to talk to Iceland about the terms and conditions of the repayment," he told the BBC's Politics Show.
Asked about how long it would take for the UK to be repaid, Mr Darling said it would take "many, many years".
But there was never any suggestion many people would vote "Yes".
That's why the referendum became an explosive political issue.
Most Icelanders argue that they should not be penalised for their government's failure to rein in spending and for the excesses of a few banks.
As we are seeing in Greece, and elsewhere in Europe, the majority of people don't want to be penalised for the actions of a few.
Iceland's rising unemployment and high living costs means the country is taking longer to emerge from recession. The economy shrank 6.5% last year and is forecast to shrink about 2.5% this year.
There is also a lingering dislike at the way Britain has conducted itself.
London used anti-terrorist legislation to freeze the assets of Icelandic banks, sparking the worst diplomatic row between the two countries since the Cod Wars fishing dispute in the 1970s.

What does the Icelandic government say?

The magnitude of those payments are such that we would have little left for anything else" Iceland's economics minister Gylfi Magnusson

Last December Iceland's parliament agreed - after much soul-searching - to approve a repayment package.
Under this deal the "debt" would be repaid over 14 years at an interest rate of 5.5%, with the interest bill deferred for the first seven years.
However, in January, following public outrage, President Olafur Ragnar Grimsson vetoed the deal. This set up the referendum.
There were last-minute talks in London to resolve the issue, with Britain and the Netherlands thought to have offered a reduced interest rate.
But hopes of a deal which would have forestalled the need for a referendum were dashed.
What are consequences for Iceland of a "No"?
A "No" vote might strengthen the government's hand in negotiations.
That said, it would still be a blow for Iceland's shaky Social Democrat-Left Green coalition, which had approved a deal.
Iceland's Prime Minister Johanna Sigurdartottir has staked much of her political reputation on backing an Icesave deal.
And the dispute has also overshadowed Iceland's application to join the European Union, which was submitted last July. This application is effectively on hold until the Icesave issue is resolved.
More importantly, a "No" vote could have severe consequences for Iceland's attempt to re-build its shattered economy and repay its debts.
An application for about $4.6bn in loans from the International Monetary Fund appears to have stalled.
The IMF has said that the Icesave dispute should have no impact on the loans.
But Britain and the Netherlands, along with Nordic countries, are thought to have made the loans conditional on Iceland repaying international debts.
About 1bn euros in foreign debt matures in 2011. Gylfi Magnusson, Iceland's economic affairs minister, has warned: "The magnitude of those payments are such that we could we would have little left for anything else."
Rating agency Moody's said recently that the deadlock may force it to downgrade Iceland's debt to junk, making it even harder for the country to borrow much-needed funds on the international market.

Source: http://news.bbc.co.uk/1/hi/business/8551673.stm