behavioral economics

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From a speech last week by Congressional Budget Office Director Peter Orszag at the Retirement Research Consortium:

Distribution of the Age at Which Primary Beneficiaries Claim Social Security Benefits by Birth Year

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Last month USA Today said gas stations were bringing back the cash discount. Indeed they were. The Nudge blog shot this picture at a Shell station in northern Virginia today.

The regular price was $3.99 a gallon. USA Today makes no mention of why gas stations are advertising a cash discount instead of a credit card surcharge – an old retailing trick – but good behavioral economists know the answer. Humans view discounts differently from surcharges. The first is an opportunity cost; the second a cost outlay. In Toward a Positive Theory of Consumer Choice, Thaler wrote:

Until recently, credit card companies banned their affiliated stores from charging higher prices to credit card users. A bill to outlaw such agreements was presented to Congress. When it appeared likely that some kind of bill would pass, the credit card lobby turned its attention to form rather than substance. Specifically, it preferred that any difference between cash and credit card customers take the form of a cash discount rather than a credit card surcharge. This preference makes sense if consumers would view the cash discount as an opportunity cost of using the credit card but the surcharge as an out-of-pocket cost.

In Choices, Values, and Frames, Kahneman and Tversky argued that the distinction is one of framing. The discount is seen as a gain while the surcharge is seen as a loss. Since humans are loss averse, we are more likely to give up the discount (the gain) than accept the surcharge (the loss).

The fact that the cash discount is applied to gas provides an interesting wrinkle to the original credit card discussion which ignored the good itself. The sharp increase in the price of is especially painful to loss averse humans whose purchasing power at the pump has slipped considerably. Filling up anywhere, with cash or credit, feels like a raw deal. On a good like this, does the gap between those who forgo the discount and those who pass shrink? In other words, if a pair of a jeans and a gallon of gas both have the same cash discount on a percentage basis, would the number of people taking each be similar?

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Since the Great Depression, the U.S. government has insured bank deposits up to $100,000 per account. So why, last week, were so many people standing in line at IndyMac, the California bank that failed under the crush of bad subprime loans? Fear, uncertainty, loss aversion, a propensity for herd behavior – behavioral economists have seen this all this before. A seminal paper on herd behavior in non-market contexts (Banerjee 1992) argued that herd behavior can occur when private information is not shared publicly. Individuals with private information act, leading to information cascades as others follow their lead, with the result being a socially suboptimal outcome.

In the case of IndyMac, no one had – or has – any private inside information about the collapse of the Federal Deposit Insurance Corporation, and yet public notices about bank deposit insurance did not keep people at home. Of course, everyone in line might have simply wanted enough money to pay a mortgage and food for a month, or had assets greater than $100,000, which meant all of their money wouldn’t have been insured. But what are the odds?

The Washington Post points out an interesting distinction between how people see the failures of human institutions like IndyMac versus the physical destruction caused by natural events like hurricanes.

People are often more fearful of man-made events than they are of natural ones. “We are rather blase about nature,” said Paul Slovic, the founder of Decision Research, an Oregon nonprofit group that studies human behavior and advises governments. “We think it’s generally benign even though we get clobbered by it over and over again. That’s why after a big storm we go back and rebuild on the spot.”

He continued: “But we are quite the opposite for certain types of risk that are human-caused, particularly if they involve something new or mysterious. We react very strongly to that. . . . If people see signs of incompetence or that the system is not being regulated or controlled, that is very worrisome.”

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Last month, the Gallup Organization hosted the inaugural Global Behavioral Economics Forum in Singapore dedicated to discovering how behavioral economics “can positively impact policy making, city planning, society building, engaged citizentry and brain gain at the national and city level.” Niether Thaler nor Sunstein took part in the event, but, according to the program, Nobel laureate Daniel Kahneman delivered the keynote. We will try to follow up with details, but in the meantime, you can watch this short video about the event by Gallup.


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Serious and nuanced thinking about the political complications arising from tensions between individual freedoms and mutual obligations, and about the government’s role in modern life have been percolating across the Atlantic in the United Kingdom. Duncan O’Leary, a researcher at the think tank Demos, has just produced a short pamphlet, “The Politics of Public Behaviour,” summarizing some of the main currents about public policy responses to the blurring of public and private lives.

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Cass Sunstein and Richard Thaler offer some thoughts in the Boston Globe on how a behavioral economist would look at mortgages.

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The Monkey Cage cites a paper by Jonathan Guryan of the Graduate School of Business, University of Chicago, and Melissa Kearney of the University of Maryland that tries to explain the following phenomenon:

In the week after a large-prize winning ticket has been purchased at a given store, that store experiences a 12 to 28% relative sales increase in lottery ticket sales. This increase fades over time, but the store’s lottery ticket sales remain elevated for up to 40 weeks. This effect increases with the size of the jackpot and with the economically disadvantaged proportion of the population.

What’s interesting about this finding is that previous research has shown that people decrease the amount of money bet on certain lottery numbers after those numbers come up winners. So they go to the store that sold the last lottery ticket, but don’t pick any of the numbers from the last jackpot? How can these apparently contradictory findings be resolved? Guryan and Kearney come up with an idea they call the “lucky store effect” in which “consumers erroneously increase their estimate of the probability a ticket bought from the winning store will itself be a winner.”

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One of behavioral economics’ seminal insights is that people value gains differently than losses. Most of us are loss averse, which means we prefer to avoid a loss more than we enjoy the satisfaction of a seemingly equivalent gain (ie. losing $100 hurts more than winning $100 despite the identical value of the money involved). Economists who have tried to measure loss aversion have found that the odds of equivalent pain to pleasure are approximately 2:1. People will work to avoid losing $50 about as hard as they will to earn $100.

With that ratio in mind, a new survey from the Mineta Transportation Institute in San Jose, California, that asked California citizens about their preferences for “green” vehicle fees for different types of cars revealed the following finding:

Californians similarly supported another green transportation finance option – a new tax-and-rebate system on all new vehicles based on how much they pollute. People who buy a new vehicle that pollutes very little would receive a rebate of up to $1,000, and people who buy a vehicle that pollutes more would pay a tax up to $2,000. People who buy a vehicle that pollutes about the average amount would not pay a fee or receive a rebate. Sixty-five percent of respondents supported this proposal, and only 30 percent opposed it.

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