Chapter 22: Behavioral Economics and Modern Economic Policy

Nobody’s ever gone broke underestimating the intelligence of the general public. ―H.L. MenckenBehavioral Economics and Modern Economic PolicyCopyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/IrwinChapter GoalsExplain the relationship between behavioral economic policy and mechanism designDiscuss the problems of implementing nudges and how the behavioral economic frame changes how policy is viewedDefine nudge and choice architecture and explain how they are related to behavioral economic policyDiscuss the concerns many traditional economists have about nudge and push policiesBehavioral Economic Policy in PerspectiveEconomic engineering is economics devoted not only to studying markets, but also to designing markets and other coordinating mechanismsBehavioral economics broadens the assumptions about behavior to:Purposeful behavior Enlightened self-interestBehavioral economic policy is economic policy based upon models using behavioral economic building blocks that take into account people’s predictable irrational behaviorBehavioral Economics and Economic EngineeringCoordination mechanisms are methods of coordinating people’s wants with other people’s desiresShadow prices are prices that aren’t paid directly, but instead are paid in terms of opportunity cost borne by the demander, and thus determine his or her choices indirectlyShadow price analysis allows you to take morals and social pressures into account in your modelsFor example, when the American League instituted the designated hitter, the quantity of bean balls thrown roseModern Economists as Reverse EngineersEconomists who use mechanism design engineering to develop policy take an existing mechanism apart with the intention of improving it Mechanism design involves identifying a goal and then designing a mechanism such as a market, social system, or contract to achieve that endMechanism design economic engineers use laboratory experiments, field experiments, game theory models, computer simulations, and a variety of other tools to come up with mechanisms that achieve the desired endsEconomists as Mechanism Design EngineersThe adoption of this mechanism design approach has transformed economic models into an enormously powerful tool for firms and governments Institutional realities impede the effectiveness of incentives in modelsAn incentive compatibility problem is a problem in which the incentive facing the decision maker does not match the incentive needed for the mechanisms to achieve its desired endChoice Architecture and Behavioral Economic PolicyOne of the findings of behavioral economics is that choice architecture impacts people’s decisionsChoice architecture: how choices are presented A nudge is a deliberate design of the choice architecture that alters people’s behavior in predictably positive waysFirms use nudges to guide their customers to make choices that benefit the firmNudge Policy and Libertarian PaternalismIn nudge policy, government structures choices facing people so that they are free to choose what they want, but also more likely to choose what is best for themA libertarian paternalistic policy is a policy that leaves people free to choose, but nonetheless guides them toward a choice that a paternalistic observer would see as good for themPeople’s choices depend on how the choices are framed and it depends on what is the default optionThe Problems of Implementing NudgesWho should decide which nudges are appropriate?Behavioral economistsBusinessesGovernmentA profit-maximizing firm is out to maximize profit, not to make its customers and employees better offIf government is going to consider nudge policy, some method must exist to decideWhat nudges to implementHow to get the nudge implementedDistinguishing a Nudge from a PushIf government has to develop a regulation and requires firms to implement a particular nudge, it’s a pushA push policy is a regulatory or tax policy to get firms or individuals to use “appropriate” nudgesIf government can institute the behavioral economic policy directly, or if a private firm chooses to implement a policy on its own, it’s a nudgeConcerns about Behavioral Economic PoliciesFew policies meet the libertarian paternalism criterionDesigning helpful policies is complicatedIt isn’t clear government knows betterGovernment policy may make the situation worseTraditional economists have expressed serious misgivings about behavioral economic policiesA Changing View of EconomistsTraditional economists argue that accepting behavioral economic policy will start the government sliding along a slippery slopeBehavioral economics questions consumer sovereignty and thus opens up a Pandora’s box of issues that the traditional economic model keeps out of sightChapter Summary Mechanism design is an engineering approach to economic problemsBehavioral economics is an outgrowth of the mechanism design approach to economicsChoice architecture is the context in which decisions are presented; a nudge is designed to influence choice architecture in a way that directs people to make choices that make them better offNudges can be useful for (1) choices where benefits and costs are separated by time (2) complicated choices with many dimensions (3) infrequent choicesChapter Summary Two categories of nudge policies are (1) advantageous default option policies (2) information and encouragement policiesTrue nudge policies are not imposed through regulation or taxation; push polices are government policies requiring firms or individuals to use certain types of nudgesBehavioral economic policy is controversialIt is not clear that government can decide what is best for people or, even if they knew what was best, they would implement the policy; government is subject to failure just like the market