Behavioral Economics Policy Impact and Future Directions (2023) / Chapter Skim
Currently Skimming:
3 Foundational Behavioral and Economic Ideas
3 Foundational Behavioral and Economic Ideas
Pages 43-68
The Chapter Skim interface presents what we've algorithmically identified as the most significant single chunk of text within every page in the chapter.
Select key terms on the right to highlight them within pages of the chapter.
From page 43... ...
Behavioral economics is a response to the fact that the traditional economic model, which assumes that rational individuals behave in predictable ways, is incomplete and fails to account for important aspects of human behavior. Evidence from the behavioral sciences has demonstrated the critical role of phenomena such as biased perception, attention bias, memory bias, and complex influences of context in decision making that are not considered in traditional economic models.
|
From page 44... ...
Economists use formal mathematics to portray the world in a set of equations intended to illustrate the key mechanisms in a given scenario they wish to analyze, taking into account many kinds of behavior. Behavioral economics models are not radically different from traditional economic models and do not constitute a complete rejection of those models.
|
From page 45... ...
will occur and then calculates a weighted average of utility in each of those possible future states. The model assumes that the individual will pick the x that maximizes utility in each such state of the world -- that the individual will make the calculation of the "best" x to choose at each future period of life, so they maximize not just utility at each single future point, or well-being in one period, but in all future periods.
|
From page 46... ...
The committee identified five core principles, as behavioral economists have framed them, that have been the basis for large bodies of research designed to test behavioral hypotheses and develop strategies to influence behavior: limited attention and cognition, inaccurate beliefs, present bias, reference dependence and framing, and social preferences and norms. This is necessarily a selective review of key behavioral principles for the development of policy.
|
From page 47... ...
Social An important aspect of the context for decision making is Preferences perceptions of how one's actions relate to those of others, and Social including the well-being of others: people make comparisons Norms between themselves and others, and they care about their social standing, how they signal their values and preferences to others, and how they conform with social norms. Behavioral economics research illustrates how each of these core principles functions in the context of decision making.
|
From page 48... ...
In all of these cases, the implicit assumption is that people are well informed of those features -- they know the tax rate, the savings subsidy, the costs and benefits of health decisions, the price of energy consumption -- and they take these incentives into account in making decisions. Counterintuitive Responses to Incentives Behavioral economists have carried out empirical research to determine whether and how these assumptions operate and to what extent limited attention and cognitive limitations may affect people's decisions.
|
From page 49... ...
Behavioral economists have developed models that accommodate the kinds of behaviors documented in these studies, and there is a vast and growing literature on such instances of limited attention and cognition. This work is also identifying which information is likely to be neglected and exploring settings in which information neglect can be mitigated (e.g., Gabaix, 2019)
|
From page 50... ...
Providing more evidence on this margin -- of the degree to which attention is allocated in accord with the perceived value of acquiring information -- could be important in the future if it leads to policies that encourage people to pay more attention to opportunities or risks that are important to their well-being. For policy developers, however, both the behavioral economic models of limited attention and of rational inattention imply that processing of complex information is costly and that complex incentives, such as taxes, or the details of health insurance plans, will often be missed.
|
From page 51... ...
Inaccurate beliefs in this context does not mean occasional or unsystematic errors: as noted, above, traditional economic models assume that people do not have perfect information. Behavioral economists have focused on instances in which inaccurate beliefs are systematic and could be corrected
|
From page 52... ...
.) One example is overoptimism: people tend to overestimate the positive aspects of their own lives, such as their likely success in a future job search effort or commitment to investing in retirement savings.
|
From page 53... ...
A second example of inaccurate beliefs, recency bias, or availability bias, occurs when people pay more attention to recent events than older ones, especially ones that they have directly experienced or witnessed. This phenomenon is illustrated in a study of people who own property in floodprone areas: many who had available to them the entire history of floods in their areas nevertheless responded more directly to recent experiences (Gallagher, 2014)
|
From page 54... ...
high pollution, people are more likely to purchase health insurance, even though the health insurance does not take effect until later in the future, when the temporary pollution has faded (Chang, Huang, & Wang, 2018)
|
From page 55... ...
. Present Bias Limited attention, cognitive barriers, and incorrect beliefs are factors in the way people perceive and comprehend economic information and the probabilities of future events.
|
From page 56... ...
Two key findings mirror each other: people are especially aversive to, and tend to delay, undertaking bureaucratic tasks, such as signing up for a benefit for which they are eligible; and people are not very sensitive to future benefits, even substantial ones, but are quite responsive to benefits perceived as immediate. Aversiveness to bureaucratic tasks is a phenomenon almost anyone would likely recognize: in the face of tasks such as calculating one's taxes, signing up for the Supplemental Nutrition Assistance Program, or changing health insurance plans, the cost of the effort of figuring out complex forms and the administrative burden looms large.
|
From page 57... ...
The traditional economic model assumes that people will rationally calculate the potential gains and losses under different scenarios, and will pick a riskier choice only if their average well-being could be significantly improved.1 But, as discussed in Chapter 2, Kahneman and Tversky (1979) found that decisions involving risk often deviated from the traditional model.
|
From page 58... ...
Kahneman and Tversky proposed that anomalies -- deviations from expected utility–based behavior -- could be explained by a simple theoretical model incorporating three key psychologically based insights. First, people exhibit loss aversion, which means that people respond more strongly to losses than the positive effect of equal-sized gains -- this effect is much stronger than is predicted by the standard model.
|
From page 59... ...
That is, if one's wages are increased by three percent when inflation is six percent, the value of one's wages is three percent lower than it had been. In part because of reference dependence and loss aversion, workers evaluate wages in nominal terms, comparing this year's pay to last year's, so a nominal wage cut is seen as a loss, while a real wage cut is not.
|
From page 60... ...
. Social Preferences and Social Norms The textbook traditional economic model assumes that people act to enhance their own well-being and tend to ignore, in making decisions, both the consequences for others and social norms that are not directly reflected in economic payoffs.
|
From page 61... ...
These behaviors do not appear in traditional economic models.5 We emphasize two points from the research on social preferences and norms. The first is that people make choices to conform to social norms consistent with their identities, and thus conformity is especially pronounced in public spheres.
|
From page 62... ...
. A second key point from this body of work is that comparisons to others often trigger responses that are consistent with the importance of social norms and social comparisons of the type emphasized in behavioral economics.
|
From page 63... ...
Conclusion 3-1: Foundational work in behavioral economics, drawing on the fields of economics, psychology, social psychology, and others, suggests the importance of five principles to consider in designing policy interventions to modify human behavior: limited attention and cogni tion, inaccurate beliefs, present bias, reference dependence and framing, and social preferences and social norms. REFERENCES Akerlof, G
|
From page 64... ...
American Economic Review, 105(7)
|
From page 65... ...
American Economic Review, 96(3)
|
From page 66... ...
American Economic Review, 96(2)
|
From page 67... ...
American Economic Review, 96(1)
|
From page 68... ...
American Economic Review, 89(1)
|
Key Terms
This material may be derived from roughly machine-read images, and so is provided only to facilitate research.
More
information on Chapter Skim is available.