Lecture Economics (9/e): Chapter 22 - David C. Colander

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.

Nobody’s ever gone broke underestimating the intelligence of the general public.

―H.L Mencken

Behavioral Economics and Modern Economic Policy

Ø Explain the relationship between behavioral economic

policy and mechanism design

Ø Discuss the problems of implementing nudges and how the behavioral economic frame changes how policy is viewed

Ø Define nudge and choice architecture and explain how they are related to behavioral economic policy

Ø Discuss the concerns many traditional economists have

about nudge and push policies

Ø Economic engineering is economics devoted not only to studying markets, but also to designing markets and other coordinating mechanisms

Ø Behavioral economics broadens the assumptions about

behavior to:

• Purposeful behavior

• Enlightened self-interest

Ø Behavioral economic policy is economic policy based

upon models using behavioral economic building blocks

that take into account people’s predictable irrational

behavior

Ø Coordination mechanisms are methods of coordinating

people’s wants with other people’s desires

Ø 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

Ø Economists who use mechanism design engineering to

develop policy take an existing mechanism apart with

the intention of improving it

Ø Mechanism design involves identifying a goal and then

designing a mechanism such as a market, social system,

or contract to achieve that end

Ø 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

Ø The adoption of this mechanism design approach

has transformed economic models into an enormously powerful tool for firms and

governments

Ø Institutional realities impede the effectiveness of

incentives in models

Ø 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

Ø One of the findings of behavioral economics is that

choice architecture impacts people’s decisions

• Choice architecture: how choices are presented

Ø A nudge is a deliberate design of the choice architecture

that alters people’s behavior in predictably positive ways

Ø Firms use nudges to guide their customers to make

choices that benefit the firm

Ø 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

Ø 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

Ø People’s choices depend on how the choices are

framed and it depends on what is the default option

Ø Who should decide which nudges are appropriate?

• Behavioral economists

• Businesses

• Government

Ø A profit-maximizing firm is out to maximize profit, not to

make its customers and employees better off

Ø If government is going to consider nudge policy, some

method must exist to decide

1. What nudges to implement

2. How to get the nudge implemented

Ø If government has to develop a regulation and requires

firms to implement a particular nudge, it’s a push

Ø A push policy is a regulatory or tax policy to get firms or individuals to use “appropriate” nudges

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

1. Few policies meet the libertarian paternalism criterion

2. Designing helpful policies is complicated

3. It isn’t clear government knows better

4. Government policy may make the situation worse

Traditional economists have expressed serious misgivings

about behavioral economic policies

Ø Traditional economists argue that accepting behavioral

economic policy will start the government sliding along

a slippery slope

Ø Behavioral economics questions consumer sovereignty

and thus opens up a Pandora’s box of issues that the

traditional economic model keeps out of sight

Ø Mechanism design is an engineering approach to

economic problems

Ø Behavioral economics is an outgrowth of the mechanism

design approach to economics

Ø 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

Ø Nudges can be useful for (1) choices where benefits and

costs are separated by time (2) complicated choices with many dimensions (3) infrequent choices

Ø Two categories of nudge policies are (1) advantageous

default option policies (2) information and

encouragement policies

Ø 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

Ø Behavioral economic policy is controversial

Ø 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