Chapter 22 - Behavioral economics and modern economic policy. After reading this chapter, you should be able to: Explain the relationship between behavioral economic policy and mechanism design; define nudge and choice architecture and explain how they are related to behavioral economic policy; discuss the problems of implementing nudges and how the behavioral economic frame changes how policy is viewed.
Introduction: Thinking Like an Economist CHAPTER 22 CHAPTER Behavioral Economics and Modern Economic Policy Nobody’s ever gone broke underestimating the intelligence of the general public ―H.L Mencken McGrawHill/Irwin Copyright © 2013 by The McGrawHill Companies, Inc. All rights reserved Behavioral Economics and Modern Economic Policy 22 Chapter Goals Ø Ø Ø Ø Explain the relationship between behavioral economic policy and mechanism design Define nudge and choice architecture and explain how they are related to behavioral economic policy Discuss the problems of implementing nudges and how the behavioral economic frame changes how policy is viewed Discuss the concerns many traditional economists have about nudge and push policies 222 Behavioral Economics and Modern Economic Policy 22 Behavioral Economic Policy in Perspective Ø Ø Ø Behavioral economics broadens the assumptions about behavior to: • Purposeful behavior • Enlightened self-interest Behavioral economic policy is economic policy based upon models using behavioral economic building blocks that take into account people’s predictable irrational behavior Economic engineering is economics devoted not only to studying markets, but also to designing markets and other coordinating mechanisms 223 Behavioral Economics and Modern Economic Policy 22 Behavioral Economics and Economic Engineering Ø Ø Coordination mechanisms are methods of coordinating people’s wants with other people’s desires Shadow 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 indirectly • • Shadow price analysis allows you to take morals and social pressures into account in your models For example, when the American League instituted the designated hitter, the quantity of bean balls thrown rose 224 Behavioral Economics and Modern Economic Policy 22 Modern Economists as Reverse Engineers Ø Ø Ø Mechanism design involves identifying a goal and then designing a mechanism such as a market, social system, or contract to achieve that end Economists who use mechanism design engineering to develop policy take an existing mechanism apart with the intention of improving it Mechanism 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 ends 225 Behavioral Economics and Modern Economic Policy 22 Economists as Mechanism Design Engineers Ø Ø Ø Institutional realities impede the effectiveness of incentives in models An 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 end The adoption of this mechanism design approach has transformed economic models into an enormously powerful tool for firms and governments 226 Behavioral Economics and Modern Economic Policy 22 Choice Architecture and Behavioral Economic Policy Ø One of the findings of behavioral economics is that choice architecture impacts people’s decisions • Ø Ø Choice architecture: how choices are presented A nudge is a deliberate design of the choice architecture that alters people’s behavior in predictably positive ways Firms use nudges to guide their customers to make choices that benefit the firm 227 Behavioral Economics and Modern Economic Policy 22 Nudge Policy and Libertarian Paternalism Ø Ø Ø People’s choices depend on how the choices are framed and it depends on what is the default option In 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 them A 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 them 228 Behavioral Economics and Modern Economic Policy 22 The Problems of Implementing Nudges Ø Ø Ø A profit-maximizing firm is out to maximize profit, not to make its customers and employees better off If government is going to consider nudge policy, some method must exist to decide What nudges to implement How to get the nudge implemented Who should decide which nudges are appropriate? • Behavioral economists • Businesses • Government 229 Behavioral Economics and Modern Economic Policy 22 Distinguishing a Nudge from a Push Ø Ø Ø If government can institute the behavioral economic policy directly, or if a private firm chooses to implement a policy on its own, it’s a nudge If government has to develop a regulation and requires firms to implement a particular nudge, it’s a push A push policy is a regulatory or tax policy to get firms or individuals to use “appropriate” nudges 2210 Behavioral Economics and Modern Economic Policy 22 Concerns about Behavioral Economic Policies Traditional economists have expressed serious misgivings about behavioral economic policies Few policies meet the libertarian paternalism criterion Designing helpful policies is complicated It isn’t clear government knows better Government policy may make the situation worse 2211 Behavioral Economics and Modern Economic Policy 22 A Changing View of Economists Ø Ø Traditional economists argue that accepting behavioral economic policy will start the government sliding along a slippery slope Behavioral economics questions consumer sovereignty and thus opens up a Pandora’s box of issues that the traditional economic model keeps out of sight 2212 Behavioral Economics and Modern Economic Policy 22 Chapter Summary Ø Ø Ø Ø Mechanism design is an engineering approach to economic problems Behavioral economics is an outgrowth of the mechanism design approach to economics Choice 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 off Nudges can be useful for (1) choices where benefits and costs are separated by time (2) complicated choices with many dimensions (3) infrequent choices 2213 Behavioral Economics and Modern Economic Policy 22 Chapter Summary Ø Ø Ø Ø Two categories of nudge policies are (1) advantageous default option policies (2) information and encouragement policies True nudge policies are not imposed through regulation or taxation; push polices are government policies requiring firms or individuals to use certain types of nudges Behavioral economic policy is controversial It 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 2214 ... engineering is economics devoted not only to studying markets, but also to designing markets and other coordinating mechanisms 22 3 Behavioral Economics and Modern Economic Policy 22 Behavioral Economics. .. economists have about nudge and push policies 22 2 Behavioral Economics and Modern Economic Policy 22 Behavioral Economic Policy in Perspective Ø Ø Ø Behavioral economics broadens the assumptions about... for firms and governments 22 6 Behavioral Economics and Modern Economic Policy 22 Choice Architecture and Behavioral Economic Policy Ø One of the findings of behavioral economics is that choice