How behavioural economics can improve your life October, 2013 Frances Woolley Carleton University 1

Outline “traditional” versus behavioural economics Some PSYC 1000 Resisting temptation Libertarian paternalism 2

The great insight of economics People aren’t stupid 3

The great insight of behavioural economics People aren’t that smart, either 4

How a non-economist makes driving safer… 5

How an economist makes driving safer 6

How a behavioural economist makes driving safer Mvo 7

Cognitive ability – e.g. attention – is a limited resource People economize on use of brain power Pay attention selectively, to what seems important, relevant – flip side of ability to focus, concentrate on one thing Awareness of limitations helps counter-act them – As a driver, realize you’re not as good as you think you are Give drivers feedback on their actual behaviour, e.g. cameras showing near-misses – As cyclist or pedestrian, understand you are invisible to inattentive drivers Make eye contact Get in their way – drivers see what is in main flow of traffic, not what is on side of road Take evasive action Further reading: Chabris and Simons, The Invisible Gorilla 8

In general: Humans have two operating systems Homo economicus – Conscious – Rational – uses logic, deduction – Deliberative – Slow – “The planner” – “System 2” in psychological literature Further reading: Thaler and Sunstein Nudge 9

And… Homer economicus Intuitive, fast Makes decisions quickly, easily Uses association “The do-er” “System 1” 10

Traditional v. behavioural economics Economics models choices of planner But much of day-to-day behaviour is governed by doer People are fallible, subject to bias Knowing biases means – Less likely to make mistakes – Use them to your advantage 11

Source: 12

Why do we succumb to temptation? For lots more on mindless eating, see 13

Mindlessness Do things without thinking – e.g. check stumbleupon, reddit, etc. Why? – “Timer wasters” give immediate, easy rewards That’s what doer wants – Studying gives short-term pain for long-term gain That’s what planner wants – self-control and discipline, like attention, is hard work Only have so much self-control – So how can planner make doer actually study? 14

Strategy 1: Impose external constraints on Doer For more, see 15

Strategy 2: Take advantage of Doer’s need for instant gratification 16

Strategy 3: Take advantage of Doer’s loss aversion Loss aversion: People hate losing stuff more than they like gaining stuff – Our brains seem to process losses and gains differently (for a good discussion, see rains.pdf) rains.pdf Different parts of the brain? For some reason, losses trigger more intense reaction? – Imagine a utility function that is kinked at the current endowment point. 17

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“Libertarian paternalism” Libertarian paternalism (Thaler and Sunstein, 2003) “An approach that preserves freedom of choice but that authorizes both private and public institutions to steer people in directions that will promote their welfare.” 19

Examples of libertarian paternalist “nudges” When arranging food in the university cafeteria, place healthy options front and centre – Doer opts for what is readily available, salient, what everyone else is doing. Ban sodas larger than 16 oz – Doer can’t be bothered to get up and order a second soda Make people have to opt out of retirement savings plans, rather than opt in – Status quo bias: people stick with default option. Related to loss aversion. 20

Discussion Some amount of “choice architecture” is inevitable – E.g. designing income tax returns signature has to go somewhere People are more honest when they sign form at top, before they fill it out, than at end, after they’ve completed it – Vital to know and discuss implications of design choices But what does “promote their welfare” mean – E.g. Lone parent earning $30K per year Will probably qualify for Guaranteed Income Supplement (GIS) in retirement RRSP savings reduce GIS, so have 80% of more effective marginal tax rate Who really benefits by encouraging that person to save? 21

Fundamental methodological challenges Methodology: Mainstream economics: Deductive Behavioural economics: Inductive Basis for normative judgments: ECON 4200: “welfare”=utility as revealed by people’s choices Behavioural economics: breaks the link between choices, preferences and well-being – Then what? 22

Can behavioural economics really make your life better? 23 Calculated by Frances Woolley from Canadian Community Health Survey