Easterlin and O'Connor (2022) on that Paradox

Richard A. Easterlin and Kelsey J. O'Connor, “The Easterlin Paradox.” In: Zimmermann, K.F. (ed.) Handbook of Labor, Human Resources and Population Economics. Springer, Cham. [Working paper version here.]

• From the Abstract: “The Easterlin Paradox states that at a point in time happiness varies directly with income, both among and within nations, but over time the long-term growth rates of happiness and income are not significantly related.”

• That is, the Easterlin Paradox concerns a disconnect between cross-section and time series data linking happiness and (real) income.

• The life satisfaction (happiness) data used in Easterlin and O'Connor come from the World Values Survey (WVS) and the Gallup World Poll (GWP). This analysis takes place at the national level (so income is real income per capita within a country).

• The WVS question: “All things considered, how satisfied are you with your life as a whole these days?” 1 (dissatisfied) to 10 (satisfied); 67 countries, on average over 27 years, for this study, with about 5 observations per country.

• The relevant GWP item: Cantril ladder, 0 to 10, worst possible life (0) to best possible life (10); 123 countries, 12 to 15 years of annual data.

• A major point of emphasis for Easterlin and O'Connor is that the key for testing is to ensure that you have long time-series data, so that you are not just capturing a boom or a bust (during which the usual cross-section positive connection between happiness and income will prevail).

• Easterlin and O’Connor find that in their data, the Paradox essentially holds when the East European transition countries are not included. (The conditions of transition and the time-span of the data from transition countries are such that even more than ten years of data might essentially be capturing a long boom.) 

• With the transition countries included, or if shorter (10 years or less) time spans are employed, happiness and income do show a positive relationship. Even in these circumstances, however, the effect of changes in income on changes in happiness is small.

• The authors argue that an income reference point (typically, social comparison) is what drives the Paradox. As everyone's income rises, your reference point (other folks' income) shifts up, so your higher income does not bring more happiness. In a recession, alternatively, the relevant reference point is your own previous income, so people on average become less happy. (That is, the Paradox might hold even in the short-run during an expansion, but a recession will cause both happiness and income to fall.) 

• China, Japan, India – all have experienced tremendous income boosts without increases in happiness.

• The authors argue that the “threshold” claim (that increased income does increase happiness until you are fairly well-off, at which point more income doesn't lead to more happiness) also is wrong: the Paradox applies to rich and poor individuals, not just the rich.

• Public policies can still raise happiness! Promotion of employment and a social safety net are good for happiness.

Evers and Imas (2019) on Mental Accounting

Ellen Evers and Alex Imas, “Mental Accounting, Similarity, and Preferences Over the Timing of Outcomes,” September 12, 2019, available at https://ssrn.com/abstract=3452943.

• Do we experience life events in a bundle – a good day, say – or do we experience life more discretely, like a good work day followed by a nice dinner? Our “valuation” (of a day, for instance) will depend on the bundling, because of prospect-theory-style reference points. If we have a good morning, do we record that "event" as complete, in the hedonic books, as it were, and then start fresh in the afternoon?

• We might get more satisfaction if we could consume a good day in two or more parts, as a good morning followed by a good afternoon, as opposed to one indivisible event, a good day. Given "diminishing sensitivity" to gains and losses (a standard element of prospect theory), we would prefer to take gains discretely, and to bundle losses together.

• But can we actually choose how to bundle our experiences to maximize our well-being, to engage in “hedonic editing”? Maybe our control over the mental accounts is limited, maybe similar things (like a good morning and a good afternoon, both spent at the office) in a day will be bundled together.

• Similarity, here, takes the form of shared salient attributes. Temporal proximity is one salient feature, and hence, all else equal, with diminishing sensitivity, people would prefer losses to occur close together and gains to be spread out – but all else is not always equal, sometimes there are other factors (salient similarities) that lead to losses being mentally separated or gains being mentally bundled.

• Evers and Imas suggest that mental bookkeeping is done to economize on the comparison of attributes. At any rate, their “hedonic accounting hypothesis” is that people prefer to suffer similar losses in a short time span but dissimilar losses in a longer time span; alternatively, similar gains are spread over time and dissimilar gains are taken closer together. The similar losses are in the same mental account, and hence, treating them jointly helps (via diminishing sensitivity) to take away some of their sting. Dissimilar losses are sort of fated to be in different mental accounts, so there is no gain to bundling them, and something to be said for postponing one of them.

• In four online experiments (using mTurk, with more than 100 respondents for each of the experiments), the authors find support for their hypotheses: (1) more similar events are more likely to be bundled into a single event; (2) the more similar two negative events, the greater the desire to bundle them (by choosing to experience them in close temporal proximity); (3) the more similar two positive events, the greater the desire to separate them temporally; and (4) rendering events more similar by increasing the salience of their shared characteristics makes them more likely to be assigned to the same mental account. 

Higgins and Liberman (2018) Reply to Gal and Rucker (2018) on Loss Aversion

E. Tory Higgins and Nira Liberman, "The Loss of Loss Aversion: Paying Attention to Reference Points," Journal of Consumer Psychology 28(3): 523-532, July 2018.

• The Gal and Rucker loss aversion article outlined in the previous post was part of a "Research Dialogue"; Higgins and Liberman's reply, outlined here, is an element of the same dialogue.

• Higgins and Lieberman agree with Gal and Rucker: the empirical support for loss aversion is not as strong as its reputation would suggest. Loss aversion is not universal. The more general (than loss aversion) notion of prospect theory – that “reference points increase people’s sensitivity to objective changes in value [p. 523]” – is still viable, however.

• Losses and gains in prospect theory are judged relative to some reference point, which often is taken to be the status quo. If the reference point is not the status quo, however, then gains (relative to the status quo) need not be less powerful than losses, even if that loss-aversion-style result would be case were the status quo the relevant reference point. Further, multiple reference points can be at play at any one time.

• Reference points tend to be outcomes which attract our attention. As a result, we are more sensitive to changes around those points than from changes elsewhere. But this increased sensitivity need not be asymmetric, need not involve loss aversion: sensitivity to either gains or losses or both can increase around references points.

• A second suggestion is that a relevant reference point when judging an outcome is what might have happened instead, the chief counterfactual; gains or losses relative to that alternative will take on intensified value. To just make a train is more enjoyable than making it easily, and to just miss it is more painful than to be much too late. Again, this approach does not suggest the sort of asymmetry that loss aversion requires.

• Reference points such as goals – 10,000 steps per day – might suggest loss aversion: step 10,000 is worth a lot more than step 10,001 – but, Higgins and Lieberman argue, goals as reference points need not involve loss aversion. Many market-based goals have built-in incentives that are more sensitive above the goal – for instance, an increased percentage of royalties from book sales – than below the goal.

• In long-term pursuits, dual reference points can be at play: the starting position might be most salient early in the process, but the ultimate goal takes on more prominence as the pursuit unfolds. Recall that Gal and Rucker suggest that what is taken to be evidence of loss aversion in the literature often can be explained by an inaction bias, where no loss aversion is at play. For long-term pursuits, the “action” alternative is the one for which this dual reference point view seems most apt, and the additional reference point (the goal) can be the source of a greater sensitivity in valuation from changes in the action alternative than in the inaction alternative. 

• Some people (the “promotion-focused”) might concentrate on progress, and others (the “prevention-focused”) might concentrate on avoiding losses. Even if the status quo is the same for both individuals, they compare it with different alternative reference points. For the promotion-focused, the status quo is a loss relative to the desired progress; for the prevention-focused, the status quo is a gain relative to the feared worsening. 

• If a prevention-focused person found herself below the status quo, she might choose risky strategies if they are her only hope of restoring the status quo. Promotion-focused people, alternatively, starting from below the status quo, will not feel all that motivated to regain the status quo (both are losses, given the reference points at work), but will be more motivated to go from the status quo to a better point. This story, for which there is empirical support, is not consistent with standard prospect-theory-style loss aversion. That is, Gal and Rucker are right, in that the psychological evaluation of negative events (losses) are not always greater than the evaluation of equivalent gains, and people are not always more motivated by the threat of losses than by the prospect of gains. 

Vis and Kuijpers (2018) on Prospect Theory and Foreign Policy

Barbara Vis and Dieuwertje Kuijpers, “Prospect Theory and Foreign Policy Decision-Making: Underexposed Issues, Advancements, and Ways Forward.” Contemporary Security Policy 39(4): 575-589, 2018.

• Risk, in both prospect theory and in useful foreign policy applications, involves outcome uncertainty—so risk considerations are important in the gains domain as well as the loss domain. 

• Probability weighting often is ignored in applications of prospect theory, but it can override the usual “risk averse for gains, risk loving for losses” result. 

• In particular, low probability gains might see risk loving behavior, and low probability losses might be met with risk averse behavior. 

• And in foreign policy applications, low probabilities for unusual events are common. 

• Multiple dimensions are relevant in foreign policy decisions, so there can be multiple reference points, and outcomes might involve gains with respect to some reference points but losses with respect to other reference points. 

• When (to whom and for what decisions) might prospect theory apply? What decisions are better described by expected utility theory? 

• Oddly, ambiguity goes unmentioned in this article.

Golman, Hagmann, and Loewenstein (2017) on Information Avoidance

Russell Golman, David Hagmann, and George Loewenstein, “Information Avoidance.” Journal of Economic Literature 55(1): 96-135, March 2017 [pdf].

• Why do you not want to see my outline of this article?

• Rational people in an individual decision-making situation – that is, situations where information possession holds no implications for inter-personal strategic concerns – should always be happy to receive accurate information if it is freely available. But people often actively avoid acquiring such information.

• Patients avoid medical information, teachers don’t read their evaluations, and, in down markets, investors don’t check the value of their portfolios. Golman et al. refer to “active information avoidance” as involving the avoidance of information even if the info is free and the person knows it is available.

• A studied ignorance might lend us moral wiggle room: for instance, if we “don’t know” the conditions on factory farms, we can live with our dining choices. (OK, that example is mine, not in the article.) We might want to maintain plausible deniability as a way to avoid unwelcome responsibilities.

• Even if you learn information, you might (strangely?) choose to ignore it.

• We might have protected beliefs, so we actively avoid information that might challenge those beliefs. We could go so far as to seek to silence dissenters from our views.

• Surely some information avoidance is good: if you will eat dessert anyway, perhaps it is best not to know its caloric load. Perhaps you can live a more pleasant life by not knowing of some looming medical problem, or about your partner’s infidelity.

• When new information becomes universally available, confirmation biases can lead to further polarization of opinions. New (controverting) information might even remind you of (and sustain) the reasons that you held your initial beliefs in the first place.

• Intelligence does not protect people against biased beliefs; rather, it might make it easier to justify one’s preferred beliefs.

• People can self-sabotage – undertake actions not fitted to their abilities, for instance – to avoid learning the quality of their talents.

• People might avoid information because they prefer that compound lotteries (that resolve over time) might best be enjoyed by only learning the final, overall outcome. (Do I want to know the score of the White Sox game in the third inning? If the Sox are behind, I will be sad, and if they are ahead, then the only new “news” I can get later occurs if they lose, and the loss will then be extra painful.)

• Sometimes people are just plain curious, they seek out information that is of no instrumental value to them.

• Humans often are mistaken in thinking that the receipt of bad news will unleash anxiety – and therefore they might be mistaken in trying to shield themselves from bad news. Sometimes the elimination of uncertainty can begin the process of adaptation to the new normal.

• Bad news attracts our attention, and so we might try to avoid potentially bad news as a method to prevent this “distraction” from occurring.

• Regret aversion might lead people to avoid information on how things would have turned out if they had taken a different path.

• People tend to be overly optimistic, and such optimism appears to hold benefits. Information might be avoided or ignored for the sake of sustaining optimism – within individuals as well as groups. 

• One reason people might try to maintain existing beliefs is that they are serviceable, even if flawed – you can only rebuild a leaky boat at sea piecemeal, you can’t tear it down and start fresh. 

• If you are committed to a belief, you will not want to acquire information challenging it. The belief might even be part of your self-image, your identity.  

• Information avoidance might help with self-control issues, such as side-stepping temptations or maintaining motivation. 

• Spoiler alert! People might avoid information to maintain pleasant suspense.

Clark and Lisowski (2017) on Prospect Theory and Moving

William A. V. Clark and William Lisowski, “Prospect Theory and the Decision to Move or Stay.” Proceedings of the National Academy of Sciences of the United States of America 114(36): E7432–E7440, September 5, 2017.

• Clark and Lisowski examine residential moves (of 70 kilometers or more) in Australia between 2010 and 2014. 

• The analysis assumes that the status quo residence represents the reference point. 

• The authors argue that the endowment effect in housing occurs because residents learn more about advantages and disadvantages of their housing, and that this raises “use values” relative to “exchange values.” 

• Previous empirical evidence indicates that the probability of moving decreases with the duration of living in the current residence; the authors, therefore, include a duration variable, as well as an indicator for owning versus renting, among their independent variables. 

• Clark and Lisowski also possess a variable that captures the extent of self-reported risk aversion on the part of the surveyed individual. It turns out that people who don’t move are quite likely to be in the top half of the population in terms of this measure of risk aversion. 

• Movers tend to be younger, and they tend to be renters in their initial residence. Couples with kids are less likely to move.  

• Both duration and home ownership are associated with decreased re-location, which the authors interpret as an endowment effect -- but are these endowment effects?

Bartling, Brandes, and Schunk (2015) on Soccer and Reference Points

Björn Bartling, Leif Brandes, Daniel Schunk, “Expectations as Reference Points: Field Evidence from Professional Soccer.” Management Science 61(11): 2646-2661, 2015; working paper version (pdf) here.

• Do soccer teams play differently, and less “rationally,” when they are in the loss domain relative to expectations?

• Betting odds give a measure of expectations for match outcomes in professional soccer; so, we can test if teams play differently, and less rationally, when they are in the loss domain (performing worse than expected).

• Indicators are the numbers of yellow cards and red cards, as well as substitution patterns.

• The rationality of any changed behaviors in the loss domain can be checked by how final outcomes are influenced.

•If a team that is favored is behind, they are in the loss domain. These teams receive more cards (by 14%), and their coaches make more offensively-minded substitutions (by a large margin), than if the game situation were the same but the team was not in the loss domain. 

• Both the additional cards and the increase in offensive substitutions seem to lead to worse outcomes for teams. 

• The additional cards when a team is in the loss domain tend to be related to frustration-style events, such as dissent or violent conduct. The loss domain is psychologically more challenging and this leads to worsened decision making.

• For more on reference points and soccer, see the BEO post on the Dickson, Jennings, and Koop (2016) analysis of Domestic Violence and Glaswegian Football. 

Professor Thaler’s American Economic Association Presidential Address

Richard H. Thaler, “Behavioral Economics: Past, Present, and Future.” American Economic Review 106(7): 1577–1600, 2016 (working paper pdf available here).

• Economics provides an approach to optimal decision making -- and that is well and good. But we should not let that model distract us from how people actually make decisions.

• When people make decisions, they make them as fallible Humans, not as textbook Econs. They remain fallible Humans irrespective of how often we are told that: (1) their decisions will look "as if" they are Econs; (2) their departures from the full Econ will be unsystematic; (3) when the stakes are high they will convert into Econs; (4) with time they will learn to be Econ; and, (5) the special magic of market settings will see to it that only Econs survive.

• Does the market "get prices right"? Consider the closed-end mutual fund with ticket symbol CUBA. Typically, CUBA is priced at about a 10-to-15 percent discount relative to its underlying assets. But after December 18, 2014, CUBA started to trade at a 70% premium over the value of its underlying securities, and premium pricing continued for about a year.

• Why? On December 18, 2014, President Obama announced that the US would normalize diplomatic relations with Cuba. The CUBA mutual fund has nothing to do with the country of Cuba.

• When Humans make decisions under uncertainty, the sort of preferences they display are not those of expected utility theory. Rather, many decisions seem to involve "prospect theory"-style preferences: (1) utility is based on changes in wealth from some reference point; (2) people are loss averse; and (3) people do not weight potential outcomes according to the objective probabilities.

• For intertemporal preferences, people often display a present bias, a taste for instantaneous gratification, and in many ways, do not exhibit exponential discounting.

• As with preferences, people also do not seem to hold fully rational beliefs. In particular, people display excessive optimism and excessive confidence in their beliefs.

• Actual choices are influenced by "supposedly irrelevant factors [p. 1595]," where the supposition of irrelevance is made within standard economic models. For instance, default settings tend to influence ultimate choices, even in high-stakes situations (such as retirement planning) where the defaults are less-than-optimal and easy to override.

• In the future, economic models will incorporate those behavioral features that best improve their predictive accuracy without imposing high costs in terms of complexity; "behavioral" will disappear as an adjective for a subset of economics, as all economics will be as behavioral as necessary.

Gilovich and Kumar (2015) on Experiences versus Material Goods

Thomas Gilovich and Amit Kumar, “We’ll Always Have Paris: The Hedonic Payoff from Experiential and Material Investments.” Advances in Experimental Social Psychology 51: 147-187, 2015. [The version outlined below has different page numbers (and perhaps other discrepancies) from the version available here.]

• Experiences provide long-lasting memories, at least relative to material goods; experiences are gifts that keep on giving. Perhaps subjective well-being (SWB) and income would be more closely related if people shifted their spending from material goods to experiential goods. 

• Vacations, concerts, dining out: these are examples of experiential goods. Electronic gadgetry and clothing fall into the material goods category. People consistently report higher happiness from experiential goods relative to material goods. 

• Experiences are better for SWB for a variety of reasons. First, they are less subject to the adaptation which, over times, erodes the pleasure boost given by a material acquisition. Experiences are more pleasurable (and interesting) to talk about, and can become embedded in our identity, our story. 

• Adaptation is helpful in allowing people to come to terms with negative events, so if bad experiences are not subject to adaptation, we could suffer long-term from unpleasant moments. But experiences tend to be malleable, so that bad experiences – the vacation where it rained the whole time – tend to be looked at more favorably, through rose-tinted glasses, over time. Indeed, the negative features of experiences can become, in retrospect, their chief virtues. 

• Even in anticipation of consumption, experiences bring more pleasure than material goods. Waiting in line is less unpleasant when it is to see a play than to buy a gadget. And after the fact, people tend to think of money spent on experiences as having been better spent than that expended on material objects. 

• The social element that is attached to many experiences is one of the sources of their SWB advantages. And talking about experiences after the fact is one of their social elements. Talking about material possessions is a bit of a snooze fest. 

• The endowment effect is connected to an unwillingness to part with something that we “own”; people tend to show larger endowment effects, greater attachments, to potential experiences than to material goods. 

• Material possessions like cars are relatively easy to compare along quality dimensions – your neighbor’s Ferrari is probably better than your Ford. But who had a better vacation, or a better time at the concert? These are harder to compare, and hence, experiences to some extent protect us against unfavorable social comparisons. And if we enjoy our concert, we are not much concerned about opportunity costs, those potentially better concerts we sacrificed to go to “ours”. 

• If you buy a bad car, you regret it, you have buyer’s remorse. But the more frequent regret in the experiential realm concerns foregone opportunities, not buyer’s remorse. And it is easy to find the good in a bad experience, but not so easy to find the upside of a malfunctioning computer. “Surprises” tend to be positive when they arise during experiences, but negative when they are connected to material goods! 

• Some material goods are purchased with the intention of using them to enhance experiences, such as watching movies with your friends and family in a home video center. But perhaps the actual consumption of these goods is less social and less experiential and even less common than anticipated. If people have the experiences in mind when they make the purchases, they may be systematically fooled, as it were, into overspending on what turn out to be merely material goods. 

• Perhaps connoisseurs are able to convert material goods (collectibles, say) into experiential goods, by harnessing the same social, identity, and even narrative advantages that other types of experiences present. 

• Can we design cities, and our lives, to maximize experience?

Clark (2014) on Adaptation and Easterlin

Andrew E. Clark, “Adaptation and the Easterlin Paradox.” Paris School of Economics, October, 2014 [pdf].

• One explanation of the Easterlin Paradox is that people care about relative, not absolute, incomes. A second explanation, addressed here, is that people adapt their reference point to reflect a higher income and so receive no extra subjective well-being (SWB) when the adaptation is complete. 

• The existing empirical evidence shows a good deal of adaptation to permanently higher incomes, but often, not full adaptation. Increasing income inequality, where richer people have recent higher-than-normal gains, can lead to a positive association in cross-sectional data between income and SWB. 

• But perhaps other contributors to well-being – employment life, health, family life, for example – are not as subject to adaptation as is income. Unemployment seems to be fairly resistant to adaptation – many people are as worse off (in terms of happiness) a few years into unemployment as they are when they first become unemployed. The same lack of adaptation applies to falls into poverty. This is the case only on average, of course, and perhaps we could invest in resilience so that adaptation to negative events would be more common. 

• On average, the happiness of marriage is subject to adaptation, so that the initial happiness boost (in many countries) is eliminated over time. Divorce is associated with a notable fall in subjective well-being that precedes the divorce for a few years, but by and large, this decline is eliminated a few years post-divorce through adaptation. Having children has no impact, on average, in long-term SWB. 

• People somewhat adapt to bad health events, but that adaptation tends to be far from complete. (Cosmetic surgery brings lasting SWB benefits (page 11)!)

Morewedge and Giblin (2015) Look to Explain the Endowment Effect

Carey K. Morewedge and Colleen E. Giblin, “Explanations of the Endowment Effect: An Integrative Review.” Trends in Cognitive Sciences 19(6): 339-348, June, 2015 [pdf].

• Endowment effects tend to be demonstrated in one of two ways: (1) the “exchange paradigm,” where people who are endowed with a good are less willing to trade it for another good than pre-endowment preferences would suggest; and, (2) differences between the willingness to pay (wtp) for a good by a non-owner and the willingness to accept payment (wta) by an owner – differences which seem to materialize about the time the non-owner becomes an owner. 

• Loss aversion is a standard underlying explanation for the endowment effect; once you own a good (or even expect to), your ownership becomes your reference point, and situations where you no longer own it are evaluated as losses relative to the reference point. 

• The authors look at five underlying mechanisms that are claimed to give rise to loss aversion and endowment effects, and offer a more general framework: “attribute sampling bias.” 

• Buyers and sellers pay attention to reference prices (low for buyers, high for sellers) that will increase their transactional utility. Prices are just one example of how buying and selling activate different cognitive frames that direct attention and recall to different pieces of information. Buyers and sellers do not have the same information readily in mind, so the endowment effect does not arise because they value identical attributes differently. People even have trouble recalling frame-inconsistent information. 

• Psychological ownership raises wta for two reasons: (1) ownership creates a connection between your identity and the good; the better that you feel about yourself, the better you will feel about the good. Losing the good can seem like a threat to your identity. (2) ownership helps you remember good feelings about the good, which otherwise might be harder to access. 

• Their attribute sampling bias explanation resembles the well-known phenomenon where people seek out information that confirms their current beliefs. 

• Sadness tends to reduce or reverse the endowment effect – it creates an implicit interest in changing your circumstances, so non-owners are more willing to acquire a good and owners are more willing to sell a good. But most frames in the exchange setting (other than sadness) tend to bias people towards maintaining the status quo. 

• People are eager to trade away a “bad”, which can’t be explained by some other approaches to endowment effects, where whatever you own you value more highly. Further, endowment effects are higher for those goods (like environmental goods) that have vague attributes, giving more room for attention to a biased sample of attributes to take effect.

Gilchrist, Luca, and Malhotra (2016) on Salient Workplace Gifts

Duncan S. Gilchrist, Michael Luca, Deepak Malhotra, “When 3 + 1 > 4: Gift Structure and Reciprocity in the Field.” Management Science, published online in Articles in Advance, January 19, 2016 [pdf of earlier version here]. 

• Previous experiments on whether an unexpected gift leads workers to increase their productivity – as a sort of reciprocal response to the gift – generally have not been able to distinguish between whether any productivity boost is due to the additional payment being a “gift,” and just the fact that the worker is being paid more. Perhaps the usual market price establishes a reference point, and any wage above that point is viewed as a gift, even if it is not framed as one. 

• The authors devise a natural field experiment – the subjects do not know that they are taking part in an experiment – to try to disentangle the effect of a higher wage from the effect of a gift. 

• Workers who have indicated interest are recruited for an online data entry position, one that only lasts four hours with no possibility of continued employment. They are offered randomly assigned wages of either $3 per hour, $4 per hour, or, $3 per hour followed by an unexpected bonus of an additional $1 per hour announced after the job has been accepted. Even the $3 per hour wage, incidentally, is a highly competitive wage offer for these workers; about 230 workers are hired. 

• Workers who receive the wage of $3 plus the $1 per hour gift show a 20% higher productivity compared to either the $4 per hour or $3 per hour workers; the productivity boost is maintained throughout the 4-hour length of the work. There is no statistical difference between the productivity of the $3 per hour and the $4 per hour workers. 

• The authors conclude that what matters for productivity is not just how much you pay, but how the payment is framed. Note that the $4 per hour workers and the $3 per hour plus $1 per hour bonus workers receive identical payments, but the workers who receive some of their pay as a gift are more productive.

Shakespeare on Choosing a Reference Point

Desiring this man's art and that man's scope,

With what I most enjoy contented least;

Yet in these thoughts myself almost despising,

Haply I think on thee, and then my state,

Like to the lark at break of day arising

From sullen earth, sings hymns at heaven's gate;

    For thy sweet love remember'd such wealth brings

    That then I scorn to change my state with kings.

 (from Sonnet XXIX)

Shakespeare on Happiness and the Easterlin Paradox

And happy always was it for that son

Whose father for his hoarding went to hell?

I'll leave my son my virtuous deeds behind;

And would my father had left me no more!

For all the rest is held at such a rate

As brings a thousand-fold more care to keep

Than in possession any jot of pleasure. 

         

(Henry VI, Part III, Act 2, Scene 2, lines 889-895)

* * ** * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * *

Who would not wish to be from wealth exempt,

Since riches point to misery and contempt?...

My dearest lord, bless'd, to be most accursed,

Rich, only to be wretched, thy great fortunes

Are made thy chief afflictions.

(Timon of Athens, Act 4, Scene 2, Lines 1641-1642 and 1652-1654)

* * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * 

Lord, who would live turmoiled in the court,

And may enjoy such quiet walks as these?

This small inheritance my father left me

Contenteth me, and worth a monarchy.

I seek not to wax great by others' waning,

Or gather wealth, I care not, with what envy:

Sufficeth that I have maintains my state

And sends the poor well pleased from my gate.

(Henry VI, Part II, Act 4, Scene 10, Lines 2904-2911)

Sadoff, Samek, and Sprenger (2015) on Food-Related Time Inconsistency

Sally Sadoff, Anya Samek, and Charles Sprenger, “Dynamic Inconsistency in Food Choice: Experimental Evidence from a Food Desert.” January, 2015 [pdf].

• The authors present the results of a natural field experiment: the subjects did not know at the time that they were participating in an experiment. 

• The subjects receive $10 in a special budget each week for two weeks; they can buy ten units of food each week, as each unit costs $1. There are 20 different food items available, half of which are healthy, and half of which are unhealthy. The selected food items are delivered to the subjects’ homes. 

• At the onset, before selection or delivery, the more than 200 subjects rate how much they like the 20 food items. Then they choose their items for the first week’s delivery. 

• At the time of delivery of the ten selected items, the subjects are given a surprise presentation of four additional goods, which can be exchanged on a one-for-one basis with any of the delivered items; so, participants have an opportunity to partly change their minds. The four additional items are foods they rated highly, two healthy, two unhealthy, and include at least one item of each type that was not in the pre-arranged bundle. 

• The idea is that any exchanges made at the time of delivery are evidence of time inconsistency; the researchers focus on exchanges that alter the healthy-unhealthy mix: 21% (46 of 218) of the subjects show such an inconsistency, and 44 of those 46 move to a less healthy mix. 

• In the second week, one day before delivery, subjects are asked if they would again like the extra four items brought for a potential exchange (with their new, pre-arranged bundle). One-third of the subjects say “no thanks,” that is, they choose to commit to not being offered a future opportunity to exchange. 

• People who are dynamically consistent in week 1 are more likely (than are the dynamically inconsistent) to say "no thanks" to the offer to have the extra items available. That is, those subjects who successfully fight temptation in week 1 are those who make most intensive use of the commitment device that eliminates temptation. Further, those who prefer not to have the option to change tend to choose relatively healthy bundles in the first instance. 

• The theoretical underpinning of Sadoff et al. (2015) derives from articles by Gul and Pesendorfer, and by Fudenberg and Levine. In these models, the mere existence of a tempting good, even if it is not chosen, in a sense alters a consumer’s reference point in such a way that the value of consuming other goods is somewhat compromised by the tempting option. People in this situation, and who understand it, will want to restrict their options, even though they are eliminating options that they know they will not choose in any event. 

• In the O’Donoghue and Rabin (2003) approach (as described here), alternatively, it is only sophisticated, present-biased consumers who know that they would succumb to temptation who find it worthwhile to restrict their future options. 

• The analysis suggests that encouraging people to make their food choices well in advance of consumption might help spur the consumption of relatively healthy foods. (Note that the grocery deliveries in the experiment generally are not consumed right away, either, and hence the additional items might not be all that tempting. Gains to precommitment might be even larger in the face of more intense temptation.) 

Dickson, Jennings, and Koop (2016) on Domestic Violence and Glaswegian Football

Alex Dickson, Colin Jennings, and Gary Koop, “Domestic Violence and Football in Glasgow: Are Reference Points Relevant?” Oxford Bulletin of Economics and Statistics 78(1): 1-21, 2016 (pdf).

• Football matches can provide emotional cues that might spur domestic violence; in particular, an unexpected loss might lead to more violent incidents. Such was the finding from a 2011 article that examined some American football games, where betting odds provided the reference point for outcome expectations. 

• Dickson, Jennings, and Koop examine the Scottish Premiership (soccer), and domestic violence in the Glasgow area from January 2003 until October 2011. Two long-term and fierce rivals, Celtic and Rangers, are based in Glasgow. Together, they are referred to as the “Old Firm.” 

• Old Firm matches (that do not have extremely “unexpected” outcomes as the rivals are always competitive with each other) are associated with increased domestic violence (by some 36%); other Scottish Premiership matches, not so. (Another event that brings a significant increase in domestic violence is the Christmas/New Year’s holiday.) 

• Unexpected outcomes only are correlated with increased domestic violence for a restricted set of matches that are very important in terms of final league standings. That is, football-related loss aversion is not generally a big deal for Glaswegian domestic violence.

Educating Behaviorally with Koch, et al. (2015)

Alexander Koch, Julia Nafziger, and Helena Skyt Nielsen, “Behavioral Economics of Education.” Journal of Economic Behavior & Organization 115: 3-17, July 2015.

• Education decisions typically involve current investments of time and effort for (probabilistic) rewards that often will be realized only many years later. Education is rife with possibilities for less-than-rational decisions, including those resulting from low willpower. There is evidence that many educational decisions indeed fall prey to irrationality, such as decisions to drop out of high school. 

• Soft skills, such as personality traits and willpower, are as (or more) important as cognitive skills in educational success. 

• Family background and inputs, peer groups, school resources, and teacher skills, have large effects on scholastic success. 

• Some teachers seem to help students build cognitive skills, and some aid non-cognitive skills. Nevertheless, “it is largely unknown what constitutes a good teacher [p. 5].” 

• On average, it seems that girls get better grades and boys score higher on standardized tests. These outcomes seem to be partly explained by gender stereotypes and approaches to competition (which themselves might depend on gender stereotypes). 

• Good grades require self-control skills. People who under-study perhaps overestimate their sophistication, or lack precommitment opportunities. Dropping out and disciplinary problems might be signs of poor self-control. 

• Personal goal setting can help, by altering reference points and thereby leveraging loss aversion. Goals should not be so ambitious that they lead to despair and abandonment, however.

• Extra incentives (such as monetary bonuses) are generally good at motivating better performance with respect to attendance and enrollment. 

• Incentives are tricky, as they work differently for different populations. For instance, some students perform better with an absolute grading scale, while others thrive in relative grading systems with only a few broad ranks. 

• Effort and ability tend to be complements, so students do better if they have a positive view of their ability. A system that offers few high grades can induce students to not try, perhaps as a protective method against possibly learning negative information about their ability. A high reward offered to a child in exchange for a high grade makes it appear that the student is not expected to do well, which can lower the student’s self-assessment of her ability and subsequently undermine effort. 

• Bad schools might need to pay bonuses to attract good teachers, but good schools, which offer more intrinsic rewards to teaching, can attract good teachers without extraordinary bonuses. 

• In terms of encouraging one’s own effort and self-control, it is good to have a peer who has slightly less self-control. Then, that person’s victories can be encouraging, while that person’s failures can be distinguished from your own prospects by their relative lack of self-control.

Stevenson and Wolfers (2008) on the Easterlin Paradox

Betsey Stevenson and Justin Wolfers, “Economic Growth and Subjective Well-Being: Reassessing the Easterlin Paradox.” Brookings Papers on Economic Activity, pages 1-87, Spring 2008.

• The Easterlin “Paradox”: Within countries at a point in time, income and subjective well-being (SWB) are positively correlated: richer people are happier. This relationship between income and SWB does not seem to hold when looking between countries, or in data over long periods of time within a country. 

• One possible resolution of the Easterlin Paradox is that reference-dependent preferences might be at work. People are happier if they are relatively rich within their country, but they don’t compare themselves with people in other countries or people thirty years ago. If happiness depends on relative income, maybe we need to have highly progressive taxation, as higher income (or work effort) for one person “imposes” a relative deprivation cost upon everyone else. 

• Stevenson and Wolfers re-examine the evidence, and the Easterlin Paradox disappears: time series and cross-country studies display essentially the same correlation between SWB and (log) income as is calculated from within-country cross-sections. On average, higher income goes with higher SWB. 

• Life satisfaction and happiness are not identical concepts, with happiness more about affect (in Kahneman's typology, System 1). Happiness is less strongly correlated than is SWB with income. Tanzania and Nigeria exhibit high happiness, low SWB. 

• A rise in income of $100 contributes more to happiness in poor countries than in rich countries – but it contributes to higher happiness in both rich and poor countries. 

• The US is the exception, with a small fall in SWB between 1972 and 2006, despite rising average income. The US data might reflect stagnation in middle-class income.

Marzilli Ericson, White, and Cohen (2015) on Simple Discounting Heuristics

Keith M. Marzilli Ericson, John Myles White, and Jonathan D. Cohen, “Money Earlier or Later? Simple Heuristics Explain Intertemporal Choices Better than Delay Discounting.” NBER Working Paper No. w20948, February 2015.

• A series of “Money Earlier or Later” (MEL) choice problems are given to 1000 participants on Amazon’s Mechanical Turk service. Each MEL problem asks a person to choose between a Small-Early option (x1, t1), where x1 is the amount of money to be received t1 time periods from now, and a Large Late option (x2, t2); the names of the options recognize that x1<x2, and t1<t2. So, are you willing to wait until time t2 (instead of t1) to receive a larger payment of x2 (instead of the smaller but earlier payment of x1)?

• Problems with existing models of discount rates are what motivate this experiment. We have already seen why exponential discounting is inconsistent with common choice behavior. But even hyperbolic or quasi-hyperbolic discounting, though they can generate a present bias, cannot explain the magnitude effect, where multiplying up the dollar amounts by a common factor leads to lower revealed discount rates: a person who will take $10 today instead of $13 a week from now (often) will not take $1000 today instead of $1300 one week from now.

• The authors propose that in MEL problems, people employ rules of thumb, heuristics, so they call their model the ITCH model, for Intertemporal Choice Heuristics. In the ITCH models, the four factors that people employ to make their decision are the absolute (x2-x1) and relative ((x2-x1)/(x1+x2)/2) differences in monetary amounts and, the absolute (t2-t1) and relative ((t2-t1)/(t1+t2)/2) time delays. These four factors are combined via a weighted sum, which turns out to be fairly stable across individuals and “frames” for the MEL problems. The use of average time and delay in determining relative changes provides a sort of reference point interpretation to the heuristic.

• ITCH explains decreasing impatience (with time) and the absolute magnitude effect: If both the early and late options are delayed by a week, the relative time delay falls, so the use of a lower discount rate results. Alternatively, increasing the stakes proportionally increases the absolute payoff, and again, a lower discount rate will be chosen by the heuristics.

• Calibration of the model on a subset of the data shows that relative money is a much larger factor than absolute money, whereas relative and absolute time have similar weights. (But the time periods were rather paltry, and were presented always in absolute form, so a different approach could raise the decision weight of the relative time component.)

• In predicting the out-of-sample data, the ITCH model out-performs all the tested alternatives such as exponential discounting or quasi-hyperbolic discounting.

• So, perhaps people do not have “a” discount rate, but rather, use some rules of thumb to make intertemporal trade-offs.

Hardisty, Appelt, and Weber (2013), on Magnitude Effects in Intertemporal Choice

David J. Hardisty, Kirstin C. Appelt, and Elke U. Weber, “Good or Bad, We Want it Now: Fixed-cost Present Bias for Gains and Losses Explains Magnitude Asymmetries in Intertemporal Choice.” Journal of Behavioral Decision Making 26: 348–361, 2013.

• A positive discount rate means that you want to capture gains immediately, and postpone losses as long as possible. Why would people have a positive discount rate? (1) opportunity cost; (2) uncertainty (for instance, you might not actually have to pay that cost if it is postponed); (3) resource slack, the belief that your budget won’t be as tight in the future; and (4) preferences themselves display present bias, or impatience. 

• The magnitude effect: people discount future small gains much more highly than they discount substantial sums. This will be the case, for instance, if preferences have a sort of fixed cost present bias. People might be willing to pay $4, for instance, to achieve an immediate reward rather than wait for a larger, later reward. This fixed cost will induce people to move to take small gains immediately, but for larger amounts (which involve larger future gains, too), they are willing to wait. 

• In the loss domain, there is evidence for small or even reverse magnitude effects: small losses are discounted less than large losses. A fixed cost present bias explains observed magnitude effects for gains, but does not predict asymmetric magnitude effects. People with a fixed cost present bias would still want to postpone losses, contrary to some empirical evidence. 

• Hardisty, Appelt, and Weber argue that people want to resolve uncertainty right away, now. Such resolution is not their only concern, but all else equal, it means that gains are taken right away and that losses are realized right away. Further, this resolution bias is insensitive to magnitude, while the other factors, such as uncertainty and opportunity costs, tend to scale with magnitude. As a result, the resolution bias yields greater discount rates for gains and smaller ones for losses. Further, small losses will involve negative discounting. In the experiments, zero and negative discount rates are common in the small loss condition.