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October 18, 2003

Behavioral Economics 101

Dear Friedrich --

Econ fan that I am, I've recently found myself poking around the corner of the field known as behavioral economics. This is a group of economists who investigate the ways in which people don't behave like rational economic agents -- cool!

Is behavioral econ a comprehensive challenge to classical theory, a helpful new addition to it, or a meaningless fad? I'd be the last person to know, of course, but I'm certainly finding it a provocative development to read about. Why? Because, enlightening as I've found it to learn the basics of econ, I've also found myself repeatedly slamming on the brakes and saying, "Hey, now wait just a minute -- people aren't like that!" In any case, behavioral econ is certainly a happenin' thing -- that at least I can vouch for. And the Nobel committee's recent decision to give an economics prize to Daniel Kahneman (who's actually a psychologist) has lent the approach a lot of credibility.

What kinds of discoveries are the behavior-econ crowd making? Here are a few examples of Kahneman's findings:

  • Most people are more strongly affected in their decision-making by vivid examples than by abstract information, no matter how much more accurate the abstract information is.
  • For most people, the possibility of a loss greatly outweighs the chance of a win. "People really discriminate sharply between gaining and losing and they don't like losing," Kahneman has said.
  • For most people, first impressions play a remarkably strong role in shaping subsequent judgments.

If you get a kick out this kind of thing, you might also enjoy some of the following resources.

  • Here's a quick, flip intro to the field by Mickey Butts for Salon.
  • Here's a longer, more substantial overview by Louis Uchitelle for the NYTimes.
  • Here's a Dan Ackman q&a with Kahneman for Forbes.
  • Here's a long Roger Lowenstein article about the field for the NYTimes Magazine, with a special focus on Richard Thaler.
  • Here's a group interview about baseball (talk about irrational); Richard Thaler is one of the participants.
  • Here's a q&a with the young Berkeley hotshot Matthew Rabin, who has already won a MacArthur "genius" grant.
  • Here's a q&a with the brilliant Gary Becker, who offers some criticisms.

Kahneman, by the way, is currently working on a way of measuring well-being that he hopes to get economists to take seriously. One recent finding: "The huge importance of friends. People are really happier with friends than they are with their families or their spouse or their child."

Let me know how you react.



PS: Incidentally, my own dippy thoughts about art, pleasure, and the obsession economists have with efficiency can be read here and here. I'm still preening myself on my proposal to get rid of the notion of "utility" and replace it with what I think of as "life is worth living units." Daniel Kahneman should feel free to contact me at the email address at the top of this blog.

posted by Michael at October 18, 2003


I agree that behavioral law + economics (BLE) is v interesting but I have two problems with the general theme of it (ie of Thaler, Jolls, Sunstein, Camerer...)

1. They tend to be quite illiberal. They argue that because people are irrational by neoclassical standards the State should step in with paternalistic policies. One paper, I think by Jolls et al argues for legislation to stop people falling asleep under sunbeds!
See also:
Regulation for Conservatives: Behavioral
Economics and the Case for "Asymmetric Paternalism" Camerer, Rabin et al.

Thaler R and Sunstein C (2003) Libertarian Paternalism. American Economic Review 93 (2) pp. 175 179.

On the one hand they argue, probably correctly, that people exhibit all sorts of biases (endowment, availability,hindsight, overoptimism...etc) yet then assume that politicians (or whoever will run these paternalistic programmes) will not suffer from such biases. Public Choice econ should have taught us this will not be the case.

2. BLE also tends to underplay the role of the market in providing/correcting for such biases (see Richard Epstein's latest book, Skepticism and Freedom, on this). The market operates by specialisation so it is not clear why traders will not account for these biases. Indeed, traders of most types, by definition, cannot suffer from the endowment effect, otherwise they would never sell anything. Also, BLE tends not to look at the evolutionary reasons why we have such biases, and how they can actually be useful if managed in very simple ways that do not require paternalistic regulation (see Gigerenzer generally and Cosmides L and Tooby J (1996) Are humans good intuitive statisticians after all? Rethinking some conclusions from the literature on judgement under uncertainty. Cognition 58 pp. 1 73.) See also current Nobelist Vernon Smith's program on experimental economics which suggests that markets operate very well in the presence of such biases. I am told by someone who should know that there is some disagrement between Smith on one side, and Thaler on the other.

So although the research of BLE is v interesting, the policy recommendations of most its exponents are wrong-headed, and actually, BLE may strengthen the case for the market and private property (which is what Richard Epstein argues). It might also strengthen the case for a revival of Hayekian econ which Vernon Smith relies heavily on.

Posted by: Peter Rossi on October 19, 2003 07:17 AM

Peter -- Thanks for the info and the thoughts. I get the willies as I go through the behavioral-econ lit myself. It's easy to see how their findings could be used to justify almost any government intervention you choose. And it seems inevitable that their findings will be used that way. On the other hand, perhaps they can also be used as support for smarter and more-modest paternalism instead, which may not be such a terrible thing -- at least it's smaller and at least it might be more effective. I've seen suggestions, for instance, related to people's reluctance to think about longterm savings. One was about companies and savings plans such as 401Ks; instead of insisting that people make a conscious choice to sign up and participate (many will avoid the choice), just make participating a condition of employment. Another was getting people to sign an agreement to have 50% of whatever raises and bonuses they receive be automatically funneled into a longterm savings account. A few such experiments were tried and apparently delivered amazing results.

But I'm very naive about these things. Do policies or experiments like these have a scary downside? I figure that we're top-heavy with bossy laws as is -- too many of them, and too many of them are dumb. I think it's immensely unlikely that a freemarket paradise will ever be with us, and that it's far more likely that we're always going to have to live with regulations and requirements. This leads me to think, what the hell, let 'em be fewer and more effective at enhancing (rather than gumming up) life.

Gets me thinking about the New Urbanism, of which many valid criticisms can certainly be made. But the hard-libertarian criticism -- which is that zoning should simply be gotten rid of -- strikes me, rightly or wrongly, as unrealistic. I think we're likely to be living in a world where zoning (or something like it) plays an important role. So I admire much about the New Urbanism, which proposes replacing zoning that leads to crappy strip malls and lonely suburbs, with zoning that leads to walkable, neighborly, town-ish-like communities. It ain't perfect, but it's semi-realistic, it's plausible, and it's better than what we have.

But you're much better informed about econ than I am. Your thoughts? Do the behavioral-econ crowd have a nefarious agenda?

Posted by: Michael Blowhard on October 19, 2003 01:35 PM

I didn't mean to suggest that the BLE people have a hidden agenda, although that would not surprise me.
Sure, if we are to have laws, they ought to be as effective as possible, and here BLE may be useful, although many in the BLE field want new laws in addition.
The other problem is that oppresive laws have frequently been advocated as being good for people (or at least some people) so BLE offers succour for proponents of such laws.
I don't know enough about savings... to comment on that although I think Epstein does in his book. I would think, though, that a look at why people don't save for the long-term may uncover government manipulation of the market, somewhere or all the way along the line, especially with regard to non means-tested welfare provision.

On zoning, I don't know if you have seen The Voluntary City, a book by the Independent Institute which has chapters on private landuse zoning. I am optimistic with regard to private gated communities, within which you might find walkable, neighbourly...communities.

Posted by: Peter Rossi on October 19, 2003 02:35 PM

Might people be happier with friends because they're so much easier to get rid of, or at least take a break from?

Having no spouse and no children (that I know of, heh heh), perhaps I overestimate the amount of work and stress in such relationships.

Posted by: j.c. on October 19, 2003 05:30 PM

There's a thought-provoking article "Libertarian Paternalism" available at that you might like to read if you haven't already. It, drawing on some behavioural economics, argues for changing the default rules, while allowing people to opt-out.

One thing I noted about the articles Michael linked to, a couple of them mentioned businesses being reluctant to lower wages since workers would regard that as unfair. However, it's very noticeable that businesses regularly lay people off, and do so in preference to cutting wages. This is a puzzle for standard economics, since by laying people off you lose know-how. So, in absence of any better ideas, some economists have asked business owners why they lay people off rather than drop wages. Business owners think they take a bigger hit on morale with their remaining workers if they lay people off. Which has interesting implications for how altrustic people are, and who they are altruistic towards.

Posted by: Tracy on October 19, 2003 09:08 PM

I've spoken with Thaler at length about behavioral economics and it does not take you where those who don't like neo-classical econ might hope (at least Thaler does not think so).

Every irrational behavior that people seem to have exists whether the people are acting in a market or in a committee. Replacing market mechanisms of decision making with central planning does not get rid of irrationality because people are still calling the shots. And at least in markets people have an incentive to be rational whereas in a committee, well, incentives can be more varied.

I would recommend the "libertarian paternalism" paper because it actually does a great job of carving out where this research can make a big difference. "Libertarian Paternalism" argues that since default options make a big difference to what people choose to do, make sure you set good defaults. You are not constraining people's choice, you're just setting good defaults, which is clearly better than allowing bad defaults.

This may not sound like much to any who hoped behavioral econ would tear down the edifice of market-worship and open the doors to widespread centralized planning, but it is a meaningful corrective to free-market zealots and, when applied in areas like personal savings, could make a huge difference to people's lives and encourage better behavior.

Great site, as always,


Posted by: Zimran on October 20, 2003 01:45 PM

Thanks to all for hints, insights, recommendations. What a great way to learn -- posting an amateurish blogposting and enjoying visits and tips from experts. The Web rules, eh?

Posted by: Michael Blowhard on October 20, 2003 03:17 PM

Tremendous site - thanks. Would you like to perhaps work with me on a related project?

Posted by: FREE PORN on May 29, 2004 07:18 PM

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