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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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
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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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
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)
Restaurant consultant who specializes in menu pricing
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
People tend not to change an established behavior unless the incentive tochange is compelling
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
Restaurant consultant who specializes in menu pricing
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
People tend not to change an established behavior unless the incentive tochange is compelling
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