2013 05 23 How Behavioral Econ Helps Econ Educators

8/21/2019 2013 05 23 How Behavioral Econ Helps Econ Educators

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2013 Midwest Economic Education Conference

Kansas City, MO May 23, 2013

Prof. Michael Staten

Director, Take Charge America Institute

Norton School of Family and Consumer Sciences

How Can Behavioral Economics Help

Economic Educators?


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Economics and Behavioral Economics

Economics: the study of choices under conditions ofscarcity

Budget constraints

Time constraints

Skills and human capital constraints

Standard Economic Model

Agents are rational

Agents are motivated by expected utility maximization

Decisions are purely selfish (no account of utility of others)

Agents revise estimates of future outcomes based on

experience and new data


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Economics and Behavioral Economics

Economics: the study of choices under conditions ofscarcity

Budget constraints

Time constraints

Skills and human capital constraints

Behavioral Economics adds cognitive constraints:

It enhances study of economic decisions, recognizing that

choices are influenced by a combination of perceptual,

cognitive and psychological factors

It isnt intended to throw out the Standard Economic Model,

just improve the accuracy of its predictions


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Pervasive Mental Biases that Can Trip Us Up

Anchoring and Framing bias: we are heavily influenced by

where we start and what we see prior to making a choice


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Simple Example: Which Line is Longer?


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Anchoring Bias

(From Kahneman and Tversky, 1974)

Estimate the following product, after it is displayed for 5seconds:

Display Option 1: 1x2x3x4x5x6x7x8 = ?

Display Option 2: 8x7x6x5x4x3x2x1 = ?

Mean estimates for Option 1 = 512Mean estimates for Option 2 = 2,250

Correct answer = 40,320


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Anchoring and Framing bias: we are heavily influenced by

where we start and what we see prior to making a choice

Availability bias: Overestimate likelihood of events easily

recalled

Loss aversion: a loss of a given size hurts more than the

enjoyment from a gain of the same size

Status Quo bias: It is difficult to overcome inertia

Mental Accounting: Money in one mental account is not aperfect substitute for money in another account


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Mental Accounting

Dustin Hoffman and Gene Hackman on mental

accounting

http://www.youtube.com/watch?v=t96LNX6tk

0U
http://www.youtube.com/watch?v=t96LNX6tk0Uhttp://www.youtube.com/watch?v=t96LNX6tk0Uhttp://www.youtube.com/watch?v=t96LNX6tk0Uhttp://www.youtube.com/watch?v=t96LNX6tk0Uhttp://www.youtube.com/watch?v=t96LNX6tk0U


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Anchoring and Framing bias: we are heavily influenced by where

we start and what we see prior to making a choice

Availability bias: Overestimate likelihood of events easily recalled

Loss aversion: a loss of a given size hurts more than the enjoyment

from a gain of the same size

Status Quo bias: It is difficult to overcome inertia

Mental Accounting: Money in one mental account is not a perfect

substitute for money in another account

Present bias: We predictably succumb to temptation when a

decision now has present gains (or costs) and future costs (or

benefits)


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Study vs. Party?


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As a special sub-area of Economic Education,

Personal Finance Needs Behavioral Insights

Most economic education gives people conceptual tools tounderstand how the world works (individuals, groups,markets, economies)

We typically measure our impact by knowledge gained, and elevationin students ability to analyze new scenarios (e.g., front page of NYTimes or WSJ)

The personal finance component of economic educationfocuses squarely on helping individuals to make betterpersonal decisions

Financial capabilityis presumably the end-goal Knowledge => financial literacy => attitudes and self-confidence Behavior (specific margins) Capability (generally prepared and competent to assess financial

options and make informed choices)


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How Well Do Americans Understand Their

Finances?

.


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Financial Capability Remains a Challenge

The financial profile of American consumers suggests the need for more andbetter skills and tools aimed at improving financial capability

Capability encompasses financial knowledge and proficiency in acting on it

Components of Financial Capability How Do We Rate?

Covering monthly expenses with income 49% have difficulty covering monthlyexpenses

Tracking spending 56% do not use a budget to guide spending

Planning ahead and saving for the future 30% have no non-retirement savings

Effectively selecting and managing financial

products

66% did not comparison shop when obtaining

a credit card (51% for auto loans)

Gaining and exercising financial knowledge34% gave themselves a grade of C,D, or F on

their financial knowledge

Sources: FINRA 2010 Financial Capability Study, NFCC 2010 Consumer Financial Literacy Survey


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The Symptoms Arent Improving, and the Financial

Challenges Seem to Be Worsening

Bankruptcy: 14 million households since 2000

Home Foreclosures: 4 million+ homes lost since 2008

Student Loan debt now exceeds credit card debt at > $1 trillion Ten-year growth in tuition costs

at 4-year private colleges: 60%

at 4-year public colleges: 104%

Unemployment rate (April 2013) for workers aged 20-29 isover 20%

Over past 25 years, 68% decline in median net worth ofhouseholds headed by someone younger than 35 (1984 to2009)


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Zoom In on a Particularly Troublesome Area:

Retirement Savings in the U.S.

Traditional Sources of Income in Retirement Pension

Home Equity

Social Security

Defined Contribution Retirement Plans/other savings

Center for Retirement Research (Boston College) offers a simplemnemonic for employees planning retirement: Remember 75 Plan on needing 75% of your pre-retirement annual income once in

retirement

Monthly SS payments rise by 75% (for the rest of your life) if youpostpone collecting on Social Security from age 62 to 70.

But, 47% of retirees surveyed in 2013 say they retired soonerthan they had planned, mostly for reasons beyond their control(health or changes at work) Source: Employee Benefit Research Institute


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The Facts About Retirement Savings in the U.S.(Sources: Pension, Home Equity, SS, Defined Contribution/other savings)

42% of private sector workers (aged 25-64) have any pensioncoverage in their current job

Home Equity: 27.5% of homeowners with a mortgage wereunderwater in December 2012 Source: Zillow

Only 24% of all workers have accumulated more than $100K in savingsand investments as of 2013 (not including home equity and anypension plans)

46% of workers say theyve completed a retirement needs calculation

40% of workers think they need to accumulate at least $500K by thetime they retire to live comfortably.

Workers who have performed a retirement needs calculationare twice as likely as those who have not to expect they willneed to accumulate at least $1 million in savings beforeretirement.


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Interventions to Bring About Population-Wide

Behavior Outcomes(e.g., more savings, healthier diets, more exercise, less smoking)

Traditionally, to shape behavior weve relied on

education and changes in incentives

Education changes incentives indirectly with info that

supports revised calculation of costs and benefits

Direct changes to incentives work, too

Higher taxes on soft drinks, gasoline or cigarettes

Tax penalty for early withdrawal of retirement savings In both cases, the rational individual recalculates

options to reach a decision


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Cognitive Model for Programs to Improve

Financial Capability

Education raisesfinancial literacy

Changes toattitudes/beliefs

create newincentives to act

Change inbehavior

increases financialcapability

Alt ti A h C t t M d l f


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Alternative Approach: Context Model for

Programs to Improve Financial Outcomes(inspired by behavioral economics: capitalizes on automatic

processes of judgment heuristics)

Use choicearchitecture andpresentation toframe options

Individualsperceptual biases

lead to (anticipated)decisions

Change in behaviorwithout changing

minds


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Context Model is the Conceptual Foundation for

Emphasis on Choice Architecture

Examples:

Defined contribution retirement savings with automatic

enrollment (employee can opt-out)

Default options on overdraft protection: customer must opt-

in to be liable for bank overdraft fees on debit cards.

In the hybrid version of the Context Model, Behavioral Nudges

can be informational (right info at the right time)

Provide specific information that clarifies the impact of an

individuals decision. Give the cognitive brain enough

ammunition to make the right choice.

The art to this approach is figuring out the right info and

how to convey it.


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Three Factors to Consider:

Cost, Contents and Calories


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Electric Power Consumption: Translate

the Meter into $


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Electric Power: Peer Comparison Appeals

to Competitive Urge (or Guilt)


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Credit Score and Distributional Info


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Behavioral-driven Disclosures in the

Credit Card Act of 2009

On each monthly credit card statement:

Issuers must disclose how long it would take to pay off the

existing balanceand the total interest costif the

consumer pays only the minimum due each month

Issuers must display the payment amount and total

interest cost to pay off the existing balance in 36 months

Total interest and fees paid on the account, year to date


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When Is the Context Model Especially Effective?

(i.e., When Do We Need a Nudge?)

When we see the benefits of an action now but the costs later

(orcosts now and benefits down the road)

When encountering decisions we make infrequently


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Remember Completing Forms Like This?


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When Is the Context Model Especially Effective?

(i.e., When Do We Need a Nudge?)

When we see the benefits of an action now but the costs later

(orcosts now and benefits down the road)

When encountering decisions we make infrequently

When feedback is not immediate (so learning takes time)

When it is hard to imagine possible outcomes, or estimate

likelihoods


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As Economic Educators, We Are

Committed to the Cognition Approach

So, what can we draw from behavioral economics toincorporate into the cognition approach?

Create ah-ha moments to alert students to their innate

foibles and the perils of the marketplace

Highlight self-commitment tools: how they work and whythey are helpful

Watch for online behavioral time machine tools to helpconnect our present self with our future self

E l f Ah H ! L


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Example of an Ah-Ha! Lesson:

Three easy ways to be tricked into spending

more in the marketplace

Framing Effect: Watch for the decoy!Presenting the same thing in different forms can alter peoples decisions

(often framed as a loss or a gain) High-end breadmaker

Restaurant consultant who specializes in menu pricing

Endowment Effect

People value a good more once a sense of ownership has been established Test driving new cars (hypothetical v. tangible)

Story Telling in Advertising

Status Quo Bias

People tend not to change an established behavior unless the incentive tochange is compelling

try it for free, cancel later


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A wine list pricing strategylow end


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A wine list pricing strategylow end


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Three easy ways to be tricked in the

marketplace

Framing EffectPresenting the same thing in different forms can alter peoples decisions

(often framed as a loss or a gain)


High end breadmaker

Endowment Effect

People value a good more once a sense of ownership has been established Test driving new cars (turns the hypothetical into the tangible)

Story Telling in Advertising (vicariously experience the good from yourarmchair)

Status Quo Bias


ry it for free, cancel later


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Three easy ways to be tricked in the

marketplace

Framing EffectPresenting the same thing in different forms can alter peoples decisions


High end breadmaker

Endowment EffectPeople value a good more once a sense of ownership has been established Test driving new cars (hypothetical vs. tangible)

Story Telling in Advertising

Status Quo Bias


So, some firms urge you to try it for free, cancel later


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Lesson #1

Being aware of these behavioral tendencies can

help people make spending decisions they are

happier with in the long run


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A Useful Concept from Behavioral Economics

Richard Thaler describes two aspects of our personality:Sometimes we are in Planner mode and sometimes we are

in Doer mode

Both perspectives are decision-makers

Planner takes the long-term view

Doer lives in the moment

Often the conflict between the Planner and Doer is

highlighted because they make decisions with different time-

horizons

Planner tries to shape the long-term environment

Doer is the producerin addition to living in the moment as the

consumer


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Individual Inconsistency is often the result

of Planner/Doer conflict

Present biasorDynamic Inconsistency: What is preferred at onepoint in time is inconsistent with what is preferred at anotherpoint in time

Can be more problematic for younger people (Future self-continuity andsteeper temporal discounting)

Examples

Current snack vs. future snack: chocolate or fruit,

Physical Fitness Choices: gym memberships

Calendar commitments

Credit Card Behavior: carrying balances when you tell yourself youare going to pay it off (but dont)

Saving (for college/vacation/retirement etc.): start today vs.tomorrow


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Present Self and Future Self

To abstain from the enjoyment which is in our power,or to seek distant rather than immediate results, areamong the most painful exertions of the human will.

Nassau W. Senior, 1836

http://www.youtube.com/watch?v=W-Cz-LK16g4

Lesson #2An unchecked doer can make aperson miserable
http://www.youtube.com/watch?v=W-Cz-LK16g4http://www.youtube.com/watch?v=W-Cz-LK16g4http://www.youtube.com/watch?v=W-Cz-LK16g4http://www.youtube.com/watch?v=W-Cz-LK16g4http://www.youtube.com/watch?v=W-Cz-LK16g4http://www.youtube.com/watch?v=W-Cz-LK16g4


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Planner to the Rescue!

Self Commitment Tools

Self-Binding Constraints or Pre-commitment Devices Place your alarm clock across room

Follow a habit of not shopping for groceries while hungry (healthierfood choices)

Automatic deduction from paycheck for regular savings accumulation Saving for retirement with automatic 401K contributions

In response to these tendencies, some employers automatically signpeople up for retirement savings upon employment. The individualhas the option of opting out.

Combined self-disclosureand pre-commitment tools aregaining popularity by harnessing social networking
http://www.networthiq.com/


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Lesson #3

You can give yourself an edge by

letting your planner commit your doer to do

the right thing

and slowing down your doer with some

informational or social cues

Behavioral Time Machine Tools:


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Behavioral Time Machine Tools:

Connect present self with future self(good reference: Daniel Goldstein, TED talk 2011)

Graphical savings simulations of retirement outcomes or debt

paydown

Numerical illustrations of lifestyles Different types of apartments available upon retirement at various

retirement savings rates

Facial transformation software

Combines self-aging effects with some simple emotional indicators in

response to different levels of current savings

Research is underway to see if this impacts individual savings decisions


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Behavioral Time Machine Tools

Recap: How Can We Harness Behavioral


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Recap: How Can We Harness Behavioral

Economics to Improve Our Financial Education

Lessons?

Create ah-ha moments to alert students to their innate

foibles and the perils of the marketplace

Highlight self-commitment tools: how they work and why

they are helpful

Watch for online behavioral time machine tools to helpconnect our present self with our future self


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Additional ReadingNudge: Improving decisions about health, wealth, and happiness,

Richard H. Thaler and Cass R. Sunstein, 2008

The Marketplace of Perceptions, Harvard Magazine, April 2006

Predictably Irrational: The Hidden Forces that Shape our Future, DanAriely, 2008

Dont stop thinking about tomorrow: Individual differences in futureself-continuity account for saving, Hal Ersner- Hershfield, et al,Judgment and Decision Making, 2009

Why Smart People Make Big Money Mistakes and How to CorrectThem: Lessons from Life-Changing Science of Behavioral Economics,Gary Belsky and Thomas Gilovich

The Battle Between Your Present Self and Future Self,Daniel Goldstein,TED talks, December 2011

Thinking, Fast and Slow, Daniel Kahneman, 2011

2013 05 23 How Behavioral Econ Helps Econ Educators

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