Narrator: Imagine you're a student in a tough economics class. You've just taken a difficult midterm exam, and the average score was a dismal 72 out of 100. The class is in an uproar, complaining about the test's unfairness, even though the professor assures everyone that the final grades will be curved. Now, imagine the professor, worried about student morale, tries a different approach for the next exam. The test is just as hard, but this time, the maximum possible score is 137. The average score is 96, which is actually a lower percentage than the first exam. Yet, this time, the students are thrilled. They feel smarter and more successful. According to traditional economic theory, this change is a "supposedly irrelevant factor." A rational person, or "Econ," would know that only the percentage matters. But real people, or "Humans," are clearly happier with a higher raw score.

This simple observation is at the heart of Richard H. Thaler's groundbreaking book, Misbehaving: The Making of Behavioral Economics. Thaler chronicles his decades-long journey of documenting the countless ways that real people deviate from the idealized, hyper-rational models that have long dominated economic thought. The book is a compelling narrative of how a collection of quirky observations about human behavior grew into a revolutionary new field that integrates psychology with economics, fundamentally changing how we understand decision-making.

Narrator: At its core, traditional economic theory is built on the assumption that people are "Econs"—perfectly rational beings who make unbiased choices to maximize their own well-being. An Econ can solve complex optimization problems, possesses perfect self-control, and is unswayed by emotion. Thaler argues that this model, while elegant, fails to describe the behavior of actual people. Real people are "Humans," and their decision-making is messy, emotional, and often influenced by factors that an Econ would ignore.

Thaler's early career was defined by his habit of collecting a list of behaviors that violated standard economic theory. The most telling example came from his own classroom. After his students complained about a low-scoring midterm, Thaler decided to change the total points on the next exam to 137. Though the exam was slightly harder, the average score of 96 points—a 70% grade—left the students feeling much happier than their previous 72% grade. This "supposedly irrelevant factor" (SIF) had a profound impact on their satisfaction. An Econ would be indifferent, but Humans cared. Thaler even began including a line in his syllabus: "Exams will have a total of 137 points... This scoring system has no effect on the grade you get in the course, but it seems to make you happier." This simple anecdote reveals the central mission of behavioral economics: to build economic models that are based on how Humans actually behave, not on how they should behave.

Narrator: One of the most significant deviations from the Econ model is how people value things. Economic theory suggests that your willingness to pay for an item should be roughly the same as the price you'd demand to sell it. However, Thaler's work demonstrates this is rarely true, thanks to what he calls the "endowment effect."

He illustrates this with the story of Richard Rosett, an economist and wine collector. Rosett had bottles in his cellar he'd bought for $10 that were now worth over $100. He would happily drink one of these bottles on a special occasion, effectively forgoing the $100 he could get by selling it. Yet, he would never dream of paying $100 for a similar bottle. For Rosett, the wine he already owned was more valuable than the identical wine he could purchase. This is because of loss aversion—the pain of giving something up is about twice as powerful as the pleasure of acquiring it. Selling the wine feels like a loss, while not buying it is merely a forgone gain. This psychological quirk explains why people demand more for items they own, from coffee mugs to basketball tickets, than they would be willing to pay for them, a clear violation of the law of one price.

Narrator: Another core concept in behavioral economics is "mental accounting," the idea that people treat money differently depending on its source or intended use, even though money is fungible. We create mental "buckets" for things like "entertainment," "groceries," or "vacation funds," and spending from one bucket can feel very different from spending from another.

This leads to another common error in judgment: the sunk cost fallacy. Econs know that money already spent is gone and should not influence future decisions. Humans, however, find this incredibly difficult. Thaler tells the story of a friend, Vince, who paid $1,000 for an indoor tennis club membership. Soon after, Vince developed a painful case of tennis elbow. A rational Econ would stop playing, as the membership fee is a sunk cost and continuing to play only causes more pain. But Vince, like many Humans, felt compelled to "get his money's worth" and continued to play in agony for three more months. He was trying to avoid the mental accounting pain of "wasting" the $1,000, even though the money was already gone. This fallacy explains why we might finish a terrible meal we've already paid for or sit through a bad movie, making ourselves worse off simply because we can't ignore the past.

Narrator: Why do we make New Year's resolutions we can't keep, or buy gym memberships we never use? Thaler explains this through a model of internal conflict between two selves: the "Planner" and the "Doer." The Planner is our forward-thinking self, who wants to eat healthy, save for retirement, and finish projects on time. The Doer is our myopic, present-biased self, who lives in the moment and is easily tempted by immediate gratification.

The struggle for self-control is a battle between these two selves. The Planner knows that a bowl of cashews before dinner will spoil everyone's appetite, but the Doer wants to eat them now. The Planner's solution is to remove the temptation—to take the bowl away. This insight led Thaler and his colleague Shlomo Benartzi to design the "Save More Tomorrow" program. This retirement savings plan asks employees to commit in the future to increasing their savings rate every time they get a pay raise. This appeals to the Planner, as the decision is for a future self. It sidesteps the Doer's loss aversion, because take-home pay never goes down. And it uses inertia to its advantage, as once enrolled, people tend to stay in the plan. The program has been wildly successful, demonstrating how understanding our internal conflicts can help us design systems that guide us toward our long-term goals.

Narrator: The strongest bastion of traditional economic theory has always been financial markets. The argument is that even if some investors are irrational "noise traders," the "smart money" of professional arbitrageurs will quickly correct any mispricing, ensuring the market is efficient and "the price is right." Thaler and his colleagues systematically dismantled this idea by uncovering clear anomalies.

One of the most glaring examples was the 3Com/Palm equity carve-out in 2000. 3Com decided to spin off its highly successful subsidiary, Palm. For a time, you could buy a share of 3Com, which entitled you to 1.5 shares of Palm plus ownership of the remaining 3Com business. Bizarrely, the market price of 3Com was less than the price of the 1.5 Palm shares it contained. This implied that the remaining 3Com business had a negative value of over $20 billion. This was a blatant violation of the law of one price. The mispricing persisted for months because of "limits to arbitrage"—it was difficult and risky for smart money to short Palm stock and correct the error. This and other anomalies, like the long-term outperformance of "loser" stocks, proved that even in high-stakes financial markets, prices can be profoundly wrong.

Narrator: After decades of documenting misbehavior, Thaler's work shifted toward a new goal: using behavioral insights to help people make better choices. This led to the concept of "libertarian paternalism," an approach that aims to "nudge" people in beneficial directions without restricting their freedom of choice. A nudge is a small feature of the choice environment that influences behavior in a predictable way.

The most prominent real-world application of this idea was the creation of the UK's Behavioural Insights Team (BIT), or "Nudge Unit," in 2010. One of its first major successes involved tax collection. Instead of sending standard threatening letters to late taxpayers, the BIT tested different messages. They found that a simple, one-sentence nudge appealing to social norms—"The great majority of people in your local area pay their taxes on time"—dramatically increased compliance rates. This small, low-cost intervention brought in millions of pounds in revenue far more quickly than traditional methods. The success of the BIT proved that a government that understands its citizens are Humans can design smarter, more effective, and less intrusive policies.

Narrator: The single most important takeaway from Misbehaving is that economics becomes a more powerful and humane science when it acknowledges that its subjects are fallible, emotional, and predictably irrational Humans. For decades, economic models were built for a fictional species of Econs, leading to theories that were elegant on paper but often failed in the real world. By observing how people actually make decisions—how they value what they own, account for their money, and struggle with self-control—behavioral economics provides a richer, more accurate map of human behavior.

Richard Thaler's journey leaves us with a profound challenge. It's not enough to simply identify our "misbehaviors." The ultimate goal is to use this knowledge to design a world that is easier for Humans to navigate. Whether in public policy, business, or our own personal lives, the question remains: now that we understand our own flaws, how can we build systems, create products, and make choices that help our better selves win?