Conference: How Can Behavioural Economics Conference: How Can Behavioural Economics Improve Policies Affecting Consumers?Improve Policies Affecting Consumers?

Brussels, 28Brussels, 28thth November 2008 November 2008

Thoughts Thoughts on “behavioural economics” on “behavioural economics” and consumer regulationsand consumer regulations

Matthew Rabin, University of California, BerkeleyMatthew Rabin, University of California, Berkeley

Conference questions

Are we yet in a position to integrate this stuff?

Does Behavioural Economics (BE) call for more interventionism? Less? Where?

What next? Research and policy tools?

Questions for me

Main insights from BE

Can BE serve to complement survey data?

Robust enough for application now?

More for some markets than others?

The postulates of Neoclassical Economics

Perfect competition Perfect information Perfect rationality

(e.g., self-regarding preferences, time consistent preferences)

How neoclassical economics tenets were relaxed over time

1930s: perfect competition => monopolistic and oligopolistic models

1970s: perfect information => asymmetric information

1990s: perfect rationality => bounded rationality

Nobel Laureates

2002: Kahneman …"for having integrated insights from psychological research into economic science, especially concerning human judgment and decision-making under uncertainty"

2002: … and Smith "for having established laboratory experiments as a tool in empirical economic analysis, especially in the study of alternative market mechanisms"

Behavioural Economics (BE)

BE studies how people actually make choices

It "increases the explanatory power of economics by providing it with more realistic foundations" (Camerer, 2003).

BE, main insights

Many, but many specific errors, too

More relevant discussing the underlying principles and the big emerging theme I’ll illustrate with specific error – bias in

predicting future tastes

BE, main insights (2)

Main principle for regulation: help people achieve their own goals

Take a set of options {x, y}, (e.g., say Adjustable Rate Mortgage and Fixed Rate Mortgage)

Consider regulation when: reason to believe consumers commonly choose x even though they want y.

A first test: any way to them to choose y? If people seem to want x no matter what, shouldn’t be in business for promoting y.

BE, main insights (3)

A useful framing of BE findings: “revealed preference” fails because choice varies with the situation (see the Experiment carried out with EU Consumer Policy officials)

Most (not all) behavioural phenomena: in environment A people choose x from {x, y}; in environment B, y from {x, y}, whereas conventional rational choice says choices should be the same. Present bias, framing effects, hot/cold gap, etc.

Want borrelnoten now? Borrelnotten 7 days from now?

Value for car while with salesperson? Next morning?

Preferences

Must use something beyond traditional economic notion of preferences to find which choices, if any, reveal true goals.

“Let consumers choose” simply not sufficient for evaluation of well-being

Use BE principles to make guesses based on peoples’ behaviour and other information (as to what choice, across a variety of environments, best represent “true preferences”.

BE intervention

General principle of BE intervention: use “light paternalism” to affect when and how people choose from {x, y}, not limiting choice to y.

“Prospective choice” better than immediate choice when there is present bias – if I want candy or cocaine, make me choose ahead of time;

“considered choice” vs. “empathetic choice”

BE intervention (2)

Letting people choose from {x, y} generally better than imposing y. This can accommodate heterogeneity in tastes and in degree of rationality.

When done right, it can encourage those who should be doing y but mistakenly don’t do so, while letting those who wisely choose x still do so.

E.g., prospective choice and self-control: making people who want to drink gin or eat candy at 2am decide before 11pm. Lets those who really want to plan for it, but those who don’t really want to, not do it at the last minute.

Why intervention?

Because market may deliver one way of choosing x vs. y, rather than what BE theories suggest best way of choosing x vs. y

E.g., free market sells people things whenever want

Tempting good consumed according to immediate preferences, not prospective preferences.

Durable goods bought when most enthusiastic, not under true long-range average enthusiasm

Why intervention? (2)

NOTE: burden is greater than observing that market provides context A, but that a BE theory tells us B would be better.

Must think through logic: if our theories are really right, why wouldn’t the market provide B?

Specific class of error and intervention illustrates:

Mispredicting Preferences

2 ways tastes change over time:1. Temporary Fluctuations (moods, cues …)2. Adaptation (paraplegia, standard of living), addiction.

Evidence: people under-appreciate (even very predictable) changes in their tastes, and hence falsely project their current tastes onto the future (e.g., shopping on an empty stomach leads people to buy too much).

Lots of examples and relevant for consumer policy. People’s preferences fluctuate.

Fluctuations can be exogenous (e.g., random moods) or might be endogenous/market-induced (e.g., sales jobs, advertising …)

Example of fluctuating preferences

Nice simple experiment, dramatic context BBGJLM (2007) studied 13 long-time adult heroin addicts

who had regularly receiving BUP, a medication Over an 8-week period, each subject was asked whether

s/he would prefer each of 12 different amounts of money (ranging from $0 to $100) to a second dose, after receiving the initial dose.

IC: Subjects were told that one of their choices, randomly selected, would be implemented. Hence, they had the incentive to choose according to their true incentives.

Example of fluctuating preferences (2)

“Deprived” (2 hours before scheduled dose) and “satiated” (rights after dose) addicts asked for their willingness to pay for the 2nd dose today or 2nd dose for 5 days hence.

Average value of an additional dose:When they would get the doseToday 5 days from

nowCurrent Deprived $75 $60Craving Satiated $50 $35

These expressed willingness to pay are for the exact same circumstances by highly experienced addict. The rational choice would be identical prices.

Example of fluctuating preferences (3)

2:1 ratio of prices Willingness-To-Pay for BUP – depending on when ask. Can’t use the “revealed preference” approach.

Which is the “true” preference? BE principles say it is probably the $35 that is most

accurate reflection of her true experienced well-being. Not because drugs are bad and this is the lowest (present

bias says 2nd column better than 1st, and projection bias says bottom row better than top

What would unregulated market provide? Probably a combination of everything except the $35!

More topical examples

Consumers currently excited by a product, either because they’ll enjoy first day, or successful salespersonship. Example of a class of regulation: Cooling-off periods

encourage “persistent choice” (for irreversible or hard-to-reverse decisions with long-term consequences, only allow implementation if made at more than one moment in time.

Oversimplifying: Markets: consumers pay up to the highest WTP Right thing in many cases: the lowest WTP E.g. Cooling-off / persistent choice Reminder: for rational guys, lowest=highest, so little harm!

Final remarks

PERSISTENT CHOICE is superior to either bans or enforcing all markets contracts. Marriage, suicide, durable goods, jobs, tattoos, etc.

OF COURSE: this may come at a cost. But when no serious cost to consumer or firm from delaying choice, little harm.

CRUCIAL NOTE: foregone sales, because consumers want to back out, does not properly count as economic cost to firm in this case: this only happens when it is a sale that should not take place.

Thanks

Matthew Rabin University of California, Berkeley