in his story Funes the Memorious, the Argentine writer Jorge Luis Borges tells the story of Ireneo Funes, a young man who, after an accident, develops a prodigious memory that makes him remember every event in detail, regardless of its age. As the character states:
“I alone have more memories than all men have had since the world began.”
Homo economicus, remember
Traditionally, economic analysis has proceeded under the implicit hypothesis that all humans are like Funes: we never forget anything and do not have incorrect or distorted memories.
Of course, this does not mean that economists were unaware of the falsity of that hypothesis. It was rather a methodological decision: since memory is a very complex variable, it was considered preferable to begin by exploring the explanatory capacity of simpler models.
But in fact, some economic phenomena are difficult to explain without appealing to memory limitations.
The inspiration for these studies comes from cognitive psychology and especially from a frequently experimentally observed phenomenon that we will call decay: memories fade over time if they are not used or reviewed.
In the field of finance
Various studies have analyzed the effect of memory impairment on financial markets. The main idea is that, by forgetting distant scenarios, investors form their expectations about stock prices from a limited sample of recent data.
This leads them to believe that if prices rise then they will continue to rise, and that if they fall they will continue to fall.
Compared to a market where investors had perfect memory, this belief generates at least four differences:
- Greater volatility or variation in prices.
- The formation of financial bubbles based on “inflated” expectations.
- Investors demand higher returns on stocks to compensate for the (unwanted) greater uncertainty and volatility. That is, shares have a higher risk premium or profitability differential with a practically risk-free asset (such as a bond from a solvent State).
- Investors are highly heterogeneous because they frequently extrapolate from different experiences.
For example, in a natural experiment in India, 1.5 million investors participated in a lottery where they were randomly assigned shares of companies that were making their first public offering (IPO). Positive IPO returns increased investors’ subsequent participation in the stock market (1.17 percent), while negative returns decreased it (-1.42 percent).
Avoid oblivion
A field experiment was carried out in different banks in Bolivia, Peru and the Philippines with new savings account clients. Randomly, some savers received periodic reminders indicating a savings goal and financial incentives.
Compared to “non-recipients” of these ads, the amount saved by these customers increased by 10 percent.
Some studies also highlight that reminders are more effective the closer they are sent to the deadline.
Forgetting as a business strategy
It has been suggested that sometimes companies exploit consumers’ lack of memory, offering offers that are then not taken advantage of due to forgetfulness.
For discounted products, which require a form and proof of purchase to be submitted to the company in advance, it is estimated that more than 60 percent of American buyers do not request them (for refunds greater of 20 dollars).
Another example is free product trials, where consumers must cancel before the expiration date to avoid automatic charges.
Some evidence suggests that many customers not interested in the product forget to cancel it. For example, in experiments where reminders are received, cancellation rates are substantially higher.
On the other hand, non-cancellation rates were 28 percent in 3-day tests and 41 percent in 7-day tests, suggesting a correlation between longer duration and more forgetting.
Economic expectations
Individuals tend to form their future expectations about inflation, unemployment or GDP by extrapolating from their recent personal experiences.
For example, for a sample of American households, it was observed that their expectations of future inflation depended largely on their memories of local grocery prices in the previous months.
This is problematic for three reasons: the CPI does not only depend on groceries, consumers often have inaccurate memories of prices, and recent local prices may have their own dynamics, different from those of national inflation.
Associative memory
In closing, it is important to note that impairment is just one of many phenomena described in the memory literature in neuroscience and psychology.
For example, another mechanism of interest is the association of ideas, by which two memories X and Y become connected if they have similar meanings or are frequently perceived simultaneously. In this way, X becomes a clue of Y (and vice versa).
Like when London evokes the idea of Big Ben (or when Marcel Proust dips his madeleine in tea and the smell brings back memories of his childhood).
Associative memory seems crucial, for example, to understanding the effectiveness of advertising. The classical economic approach conceives this as a way of transmitting new information about a brand.
This is partly true, but an important goal of advertising campaigns is to create positive associations between the advertised good or service with inspiring or pleasant ideas, such as the image of a beautiful person.
If the consumer subsequently thinks about the good, it is likely that he or she will also consider those associates and a positive affective state will be generated that may invite him or her to purchase the good or make the consumption experience more pleasant.
In short, there are still great opportunities for interaction between economics, neuroscience and psychology in the field of memory.
This article was originally published on The Conversation. Read the original. Irene Espinedo Lorenzo, student at the Faculty of Social and Legal Sciences of the Carlos III University of Madrid, is co-author of this article.
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