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Behavioural Economics: Some Findings, Implications, and Policy

Behavioural Economics: Some Findings, Implications, and Policy. Jack L. Knetsch Simon Fraser University Nanyang Technological University Singapore Civil Service College. End of Chapter Question.

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Behavioural Economics: Some Findings, Implications, and Policy

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  1. Behavioural Economics: Some Findings, Implications, and Policy Jack L. Knetsch Simon Fraser University Nanyang Technological University Singapore Civil Service College

  2. End of Chapter Question You won a free ticket to see an Eric Clampton concert (no resale value). Bob Dylan is performing on the same night and is your next best alternative. Tickets for Dylan cost $40. You would be willing to pay up to $50 to see Dylan. Assume no other costs of seeing either. What is the opportunity cost of seeing Clapton? • $ 0 B. $10 C. $40 D. $50 (Ferraro and Taylor, 2005)

  3. Answers of 200 Professional Economists The opportunity cost of seeing Eric Clapton is: A. $ 0 25.1% B. $10 21.6% C. $40 25.6% D. $50 27.6%

  4. Admonishmentsto Analysts “A core set of economic assumptions should be used in calculating benefits and costs”. (Arrow, et al., 1996) “Any measurement technique … should be consistent with standard economic theory of individual preferences and measurement of welfare changes”. (Freeman, 1993)

  5. Loss vs. Foregone Gain Changing Pension Plan Contributions: From: Pay out of current earnings (a loss – very salient) To: Portion of future wage increases (forego gain in future – not very salient) Savings rates: Pay from current earning 3.5 % Pay from future wage increases 13.4 % (Thaler / Benartzi 2007)

  6. Mental Accounting Std. Theory Assumes Money is Fungible Evidence / Experience Suggest Not Spend dividends, not capital Decoupling purchase from paying Sunk cost effect Dedicated funds (ear-marking) Avoid debt

  7. Power of Default Organ donation consent: Opt-In (U.S., Canada, others) <29% Opt-Out (Europe, Singapore, etc.) >80%J Auto insurance Buy Cheap Buy Expensive NJ, Cheap default 80% 20% PA, Expensive default 25% 75% New employee enroll in pension plan: Information, but Opt-In 25% enroll Automatic unless Opt-Out 80% enroll

  8. The Power of Free Lindt Truffle @ 15¢ 73% Hersey’s Kiss @ 1¢ 27% __________________ Lindt Truffle @ 14¢ 31% Hersey’s Kiss @ 0¢ 69%

  9. Anchoring Last Two Digits of SS Number 00-1920-3940-5960-7980-99 Mouse $ 8.64 $11.82 $13.45 $21.18 $26.18 K’board 16.09 26.82 29.27 34.55 55.64 Book 12.82 16.18 15.82 19.27 30.30 Chocolate 9.95 10.64 12.45 13.27 20.64 OK Wine 8.64 14.45 12.55 15.45 27.91 Good Wine 11.73 22.45 18.09 24.55 37.55 • Mean 11.25 17.06 16.94 21.37 32.99

  10. Certain vs. Risky Outcome ( A) Certain + $800 Or (B) 80% Chance of + $1000 20% Chance of $0 _________________________________ (Y) Certain - $800 Or (Z) 80% Chance of - $1000 20% Chance of $0

  11. Focusing Illusion First ask well-being, then dates r=.012 First ask dates, then well-being r=.660 Ice CreamLarge Not FullSmall Overflowing Separate $1.80 Separate $2.23 Together 2.02 1.81

  12. What is Fair? Store auctions last doll to highest bidder Store keeps money Unfair 74% Fair 26% Store donates money Unfair 21% Fair 79% [One party gains at the expense of another unfair] Housing scarce, raise rent 25% Fair Costs increase, raise rent 75% Fair [OK to pass on cost increases] Cut worker’s wage 39% Fair Cut worker’s bonus 80% Fair [Wage cut a loss, bonus cut a foregone gain]

  13. Deservedness You and another person agree to work …the time and work is the same. One of you will be paid $75 and the other $25. Before beginning you must choose between two rules Require … give $25 to other person 90% Allow person paid $75 to keep it 10% You are about to play simple game w/ winner depend entirely on chance. Winner gets $75 Require winner to give $25 to loser 40% Allow winner to keep the $75 60%

  14. Ability to Express Monetary Valuations Punitive Damages -- Responses to 10 Scenaios Correlations Outrage (bounded scale) .87 Punishment – punitive intent (bounded scale) .89 $ Awards (unbounded scale) .42 “…people’s moral judgments widely shared… difficulty mapping such judgments onto an unbounded scale of dollars” (Sunstein, Kahneman, Schkade, 1998)

  15. Valuing Changes Assessments Used in: Benefit-Cost Analyses Risk Assessments Setting Priorities Estimating Damages Less Formal “Habit-of-Mind” Measure to Reflect Real Change in Welfare

  16. Monetary Measures of Changes in Economic Welfare (Values) Gain = How much person is willing to pay for it (WTP) Loss = How much person demands to accept it (WTA) In Practice, Largely Indifferent to Measure Used

  17. WTP / WTA Assumed Equivalent “… we shall normally expect the results to be so close together that it would not matter which we choose”. (Henderson, 1941) “… economists expect that the difference between them will be small in most cases” (U.S. EPA, 2000) Justification to use WTP for nearly all changes Choice considered matter of convenience “used...because often easier to measure and est.”

  18. Working Assumption of Equivalence Not Consistent with the Evidence People Value Losses More than Gains (Reference or Endowment Effect) Value of 50 percent Chance Win $20: Willing to pay to Acquire $ 5.60 Compensation to give up $11.02 (Kachelmeier / Shehata, 1992)

  19. Preferences: Mug vs. Chocolate Prefer MugChocolate Simple Choice 56% 44% Give up Chocolate for Mug 10% 90% Give up Mug for Chocolate 89% 11% (Knetsch, 1989)

  20. Survey and Natural Expts. Bird Hunters & Habitat (Hammack/Brown 74) Willing to pay to preserve $ 247 Compensation to accept loss 1044 Price elasticity of eggs (Putler, 92) Price decreases (gains, insensitive) -0.45 Price increases (losses, sensitive) -1.10 Investors reluctant to realize losses (Odean 98) Sell “winners” and keep “losers” Shares sold return 3.4% more than those kept

  21. Valuations: (1) Change from Reference State (2) Losses Greater than Gains

  22. Equivalent and Compensating Variation WTP and WTA Measures W2 U1 W0 U0 W1 Q0 Q1

  23. Two Measures of Positive Change and Two Measures of Negative Change Positive Changes In Domain of Losses => WTA to forego In Domain of Gains => WTP to acquire Negative Changes In Domain of Losses => WTA to accept In Domain of Gains => WTP to avoid Choice More an Issue of Domain than of Direction

  24. Survey Values of Changed Risks of Having Bicycle Stolen MeanMedian Positive change: WTP to reduce risk 20.19 12 WTA forego reduced risk 46.29 35 Negative change: WTA to accept increased risk 41.59 30 WTP to avoid increased risk 16.53 10 (Zong, Knetsch, and Tang, 2010)

  25. Thought Experiments & Intuition Blocking of roadway Occurrence – Incur Loss: WTA to accept (sum leave indifferent blocked travel and reference of normal travel) Clearing the road—Eliminate Loss: WTA to forego (sum indifferent between leave blockage and reference of normal travel) Physical Assault Occurrence – A Loss: WTA to accept beating (sum leave indifferent beating and reference of not being beaten) Stopping the beating – Eliminate Loss: WTA to forego (sum leave indifferent continuing beating and reference of not beaten) Robbery Accident Oil spill Serious illness

  26. The Reference State and Values Not Matter of Legal Entitlement More: Expectation - Psychological Ownership Reference Could Change with Gain or Loss Question is: Does It??? Adapt? Likely Quantum not Measure

  27. Choice of Project Two Transportation Projects, A and B: Equal: cost, beneficiaries, time saving A: Shorten distance B: Replace failed bridge, eliminate detour ShortenIndifferentReplace Univ. Students 18% 13% 69% Econ Students 19% 21% 60% Sing. Civil Serv. 13% 22% 65% Int’l Experts 10% 20% 70%

  28. Choice: Domain, not Attribute Loss (e.g. Oil Spill)—WTA : Reduce Size a Change in Loss – WTA Reduce Risk of Spill –WTA Value of Changing Risk of Bicycle Theft: Increased Risk: WTA to Accept Decreased Risk: WTA to Forego

  29. The Bias and Social Well-Being Near Universal Use of WTP for Losses, Risks of Losses, and Reductions/Elimination of Losses Bias against Losses relative to Gains Studies of Well-Being (Happiness) Suggest Losses Big Determinant Health, Family, Jobs, Friends, Environment

  30. Recent (Influencial?) Books Richard Thaler and Cass Sunstein, Nudge: Improving Decisions About Health, Wealth, and Happiness Dan Ariely, Predictably Irrational: The Hidden Forces that Shape Our Decisions George Akerlof and Robert Shiller, Animal Spirits: How Human Psychology Drives the Economy and Why it Matters for Global Capitalism Wm. Congdon, Jeffrey Kling, and SendhilMullainathan Policy and Choice: Public Finance Through the Lens of Behavioral Economics

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