behavioral economics

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Innovations for Poverty Action’s Dean Karlan and Jacob Appel are out with their new book, More than Good Intentions: How a New Economics is Helping to Solve Global Poverty. As the title suggests, it’s based around their work applying behavioral economics to problems in international development. The focus is on making small changes in areas like banking, insurance, and health care that can produce dramatic improvements in decision making and well-being.

Says Richard Thaler: “Karlan is one of the most creative and prolific young economists in the world. His research lies at the intersection of two of the hottest areas in the field: behavioral economics and development microfinance… [His and Appel’s book is] a good follow-up to Freakonomics, Predictably Irrational, and Nudge with a development and poverty spin.”

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Are good old-fashioned cash rewards nudges? This is a common question we hear. Financial incentives are listed as one potential tool for smart choice architecture. To ignore them is to ignore volumes of traditional economic work. That’s silly. Nudge is, after all, a book about psychology and economics. But financial incentives have a behavioral element, as Michael Kremer and Rachel Glennerster point out in a new, excellent review of behavioral economics and economic development published in the Boston Review. Since people are not good investing a little bit now to get a lot later (myopia, procrastination, status quo bias all get in the way), behavioral economics steps in to try and jump start these investments through small financial incentives. The basic point is that the context around the incentive (its size, when it’s delivered, how salient it is made) are all critical to its effectiveness. Uncovering these contextual lessons is one of behavioral economics broad goals.

Even small incentives and costs have a surprisingly large impact on behavior. In Malawi, where different magnitudes of conditional cash transfers were tried, the smallest incentive was sufficient to achieve the average effect. An evaluation in Kenya found that providing a free school uniform could increase attendance of young children by 6.4 percentage points. There is evidence that covering the cost of school uniforms for adolescent girls not only reduces dropout rates, but also reduces rates of teen pregnancy. Conditional cash transfers can be used to get larger sums of money into the hands of the poor, but if the goal is simply to get children in school, providing smaller transfers to more people in the poorest countries may be the most effective use of resources.

In addition, the timing of costs matters more than would be expected in a simple model. This has been found in education, health, and agriculture in Latin America and Africa. Cash-transfer programs that set aside resources and pay them out when school fees are due induce much higher rates of attendance than do programs that pay out earlier. This also leads to better attendance than scenarios in which the poor cannot borrow and take cash whenever they can get it.

Children are also highly influenced by their peers. Evidence from Mexico and Colombia shows that when conditional cash transfers induce the poor to go to school more, the slightly better off, who are not eligible for the program, also go more, presumably because it’s not much fun being out of school if all your playmates are there. Similarly, in Kenya, when the best-performing girls were offered scholarships, they worked harder and attended school more, as one might expect. But so did boys, teachers, and girls who had no hope of winning the scholarship.

While there is much yet to learn about the relative effects of different pressures and incentives, the broader lesson—that adjustments to timing and small adjustments to costs can have surprisingly large impacts on the effectiveness of a program—appears sound.

 

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Posts from a recent symposium on behavioral law and economics held by truthonthemarket.com.

The topic of the symposium is necessarily broad. Behavioral economics itself has made a significant contribution to increasing our understanding of when individual decision-making deviates from the rationality assumption at the heart of the conventional microeconomic theory. Behavioral law and economics now reaches all corners of the law. The rise of behavioral economics raises interesting sets of questions both within the domain of economics itself: what are the costs and benefits of the intersection of psychology and economics? What explains the remarkable success of behavioral economics in the behavioral law and economics literature? Will the phenomenon have staying power? Is it in fact the case that behavioral law and economics is gaining traction in the current regulatory landscape? We do have the Consumer Financial Protection Bureau. But what else? On the specifics, what are the sorts of behavioral law and economic policy prescriptions in other areas of the law such as antitrust, consumer protection, and intellectual property? Would such interventions be successful? Will there be long-term costs of approaches built on the concept that one can rely on the the government to correct decision-making errors? And further, has the implementation of regulatory proposals by the behavioral law and economics camp in practice remained faithful to the insights produced by the behavioral economics literature in theory, laboratory experiments and the field? Or have proposed “nudges” merely take the form of default rules which map onto the policy preferences of the academic advocate?

Richard Thaler responds to the many posts and comments. An excerpt:

The idea that behavioral economists want to create some sort of new nanny state is preposterous. Many leading behavioral economists, including me, have strong libertarian leanings. Some are actually card-carrying libertarians. Still, much of the criticism of the field comes from conservative, free-market economists who just “know” somehow that, no matter what we say, behavioral economists are part of some left-wing, probably communist, and certainly socialist conspiracy. I am not sure how to convince anyone that this is not true. But here is what I really think. The philosophy of libertarian paternalism that Cass and I advocate in Nudge, could accurately titled Free to Choose, 2.0. If people would read with care what we have written, they will see that this is accurate. We do not advocate a larger role for government, just a more efficient, smarter way of achieving a government’s goals, whatever the democratic process determines that they should be. Does anyone advocate dumber and costlier instead? Tom Brown made this point very nicely with his excellent illustrations of effective and ineffective communications efforts.

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How far has behavioral economics come?

Prospect theory now has its own facebook page, set up by Risk Psychology last April.

How far does behavioral economics have to go?

The page has three members. Supply and demand also has its own facebook page. Not sure when it was created, but there are 127 members, who seem to post items on the wall frequently.

For more on part I, click here.

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In terms of recognition and respect, behavioral economics has certainly come a long way in the last 25 years. But it is still a Hibernian outpost in the great Roman Economics empire. One of the newest metrics for evaluating its impact is the auto-suggest feature in many search engines that has become quite popular since Google aired its ode to the long-distance romance during the Super Bowl.

In order to compare regular economics and behavioral economics, the Nudge blog typed in the first word of a few major concepts from each field into Google.

From economics, there is “supply and demand,” “opportunity cost,” and “economies of scale,” all of which appear to be quite popular. Notice that the phrases themselves are popular, as well as ones that add “examples” to the end of the phrase.

From behavioral economics, there is “prospect theory,” “endowment effect,” and “bounded rationality.” The first two still have a ways to go before becoming part of everyday parlance. Bounded rationality, on the other hand, looks potentially well positioned to make it. Of course, how many phrases out there start with “Bounded”? More or less than phrases that have “ou” as the second and third letters in the first word? (That’s a behavioral economics special for all the careful readers out there.)

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Says Psychology Today.

One advantage is obvious: Buyers scanning listings online usually set a minimum and maximum price. These are round numbers (often chosen from a menu on the listing site). In the example above, a buyer whose maximum price was $1 million would see a house listed at “$999,000 to $1,194,876,” but not a house listed at a single price higher than a million. (Of course, this depends on listing sites being able to handle price ranges.)

Another advantage of this trick is simple confusion. Just about everyone knows that a listing price of $X typically signals that the seller is willing to accept a good deal less than $X. In this market, few sane buyers are going to offer list price. Having two prices upsets this comfortable strategy. Do you offer the low price of the range? Less than the low price? Or do you make an offer somewhere in the range? Maybe you really, really want the house and want to make a preemptive offer. Do you offer the high price?

This suggestion still doesn’t get around the problem inherent in the behavioral economics diagnosis of the current housing market. Loss averse sellers don’t want to sell a property for less than they paid for it, or less than what they think it’s worth based on peak bubble prices. Whether she picks a range or a single price, the seller has to overcome the psychological hurdle or realizing that the value today isn’t the value yesterday.

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Richard Thaler, speaking recently at a World Economic Forum panel.

“Let’s go back to Adam Smith,” Mr. Thaler suggested on a high-profile panel on Rebuilding Economics. “No, actually, let’s go back to Adam.”

“When it was just the demand for apples, the model still worked pretty well,” he said. “But today we have Apple and the iPhone pricing strategy.”

“Adam could deal with apples — as long as there were no serpents and women,” Mr. Thaler added. “When you add serpents and women, you get self-control problems that the model cannot deal with.”

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MacArthur winner and Harvard behavioral economist Sendhil Mullainathan talks about a tricky set of social problems — those we know how to solve, but don’t. We know how to reduce child deaths due to diarrhea, how to prevent diabetes-related blindness and how to implement solar-cell technology … yet somehow, we don’t or can’t. Why?

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This month’s Capital Ideas, published by the University of Chicago Graduate School of Business, features work done by our colleague Oleg Urminsky on the relationship between rewards and human efforts and motivations. The classic work on this puzzle was conducted in the 1930s by psychologist Clark Hull who noticed that rats ran faster as they moved closer to food. (Food they could see on a straight runway, that is.) Sensing the propinquity of the reward, the rats worked harder to obtain it. Hull called this phenomenon the “goal-gradient” hypothesis.

Urminsky, along with Ran Kivetz of Columbia University and Yuhuang Zheng of Fordham University, turned their attention to customer reward programs to further study Hull’s hypothesis, by analyzing how the distance to a final reward affected customers’ purchasing decisions.

Continue reading the post here.

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Peter Orszag responds to yesterday’s post about the relevance of penalties on wage earnings before reaching full employment age – also known as the retirement earnings test.

It is true that if people don’t understand how the retirement earnings test (RET) works, knowing that it no longer applies starting at the full benefit age could cause some people to claim at that age. (Those who do understand the RET know that the recalculation that occurs when a beneficiary subject to the RET reaches the full benefit age compensates them for the benefits offset while they were still working – again making the benefit actuarially fair).

Continue reading the post here.

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