Richard H. Thaler, “From Cashews to Nudges: The Evolution of Behavioral
Economics.” American Economic Review 108(6): 1265–1287, June 2018.
• "In the beginning there were stories [p. 1265]." Those stories were of anomalies with respect to the standard economic model of rational choice. For instance, the "cashews" in the title refer to an incident where guests thanked then-graduate-student Richard Thaler for rendering inaccessible the pre-dinner snacks: the guests seemed to believe that the loss of the option to eat cashews made them better off.
• A key development in behavioral science was the work of Kahneman and Tversky, which indicated that departures from fully rational behavior are systematic. This non-randomness suggests that modifications of the rational model could do a better job at explaining behavior. Further, Kahneman and Tversky's prospect theory offers a simple explanation for some of these systematic departures.
• Standard economic theory often is presented as a descriptive theory of how people choose as well as a normative theory of how people should choose. It is better at the latter (normative) task than at the former (descriptive) task.
• Thaler and Shefrin propose a planner/doer model of intrapersonal (or intra-firm) conflict; the planner component of a decision maker can alter the doer's incentives by employing commitment strategies or deploying the (payoff-compromising) induction of guilt.
• Economics typically assumes that dollars are fungible, that the best way to spend them is independent of where the dollars originated. But people assign income to different "mental accounts" according to its origin. Some income might be allocated to a mental checking account, so it is psychologically available for spending, whereas other funds might be assigned to mental savings, and therefore, are psychologically unavailable for quotidian consumer purchases. Dollars, in practice, are not fungible -- as anyone who has ever "played with house money" knows.
• Is it fair to raise prices just because demand increases, as when a snowstorm makes snow shovels highly sought after? Many people (but not many economists!) think that such price increases are unfair, and might punish businesses that engage in such behavior.
• The endowment effect is when mere “ownership” of an object (like a coffee mug) seems to raise the valuation that the “owner” places on the object. Endowment effects reduce the willingness-to-trade of owned objects, and some of Professor Thaler's work shows that endowment effects are common even when decision makers operate in markets, and when they have opportunities to learn over time.
• Even in financial markets, with their ongoing nature, high stakes, and sophisticated participants, security prices are not always right: for instance, parts of a firm can bizarrely be deemed more valuable in financial markets than is the entire firm (even though the complementary parts are not themselves of negative value).
• Draft picks in the National Football League are mispriced: the best value for teams seems to lie in draft picks in the early part of the second round. The people making the draft picks might be excessively optimistic about their ability to identify winners when making first round picks.
• In the standard rational choice model, nudges (aspects of the choice architecture that don't affect standard payoffs or incentives) would not have much influence on choices -- but they often do.
• Some firms try to use nudges to take advantage of those systematic departures from rational behavior on the part of their consumers; Professor Thaler calls this nefarious sort of choice architecture "sludge."
Yuanyuan Liu and Ayse Onculer, “Ambiguity Attitudes over Time.” Journal of Behavioral Decision Making 30: 80-88, 2017.
• Ambiguity aversion is not uncommon when dealing with relatively high-probability gains; ambiguity neutrality or even ambiguity seeking comes into play for low-probability gains. (Ambiguity attitudes can be quite different for loss settings or for mixed gain-loss scenarios.)
• This article investigates whether delayed resolution of uncertainty changes attitudes towards ambiguity. The authors find that a one-year delay tends to undermine ambiguity aversion in those high-probability gains scenarios.
• Liu and Onculer propose that for immediate prospects, the affective system (Kahneman’s system 1) makes the call, but that in asking people to think about risks with future resolution, the cognitive (system 2) tends to take over, and dissipates the ambiguity aversion that appears in the high-probability condition.
• For low-probability gains, system 2 is in charge even for immediate prospects, so delay has no effect on ambiguity attitudes.
• Affect can influence decision making. Likely events tend to be psychologically closer than unlikely ones, increasing reliance upon affective decision making. Likewise, immediacy also triggers affective decision making. Temporal distance, alternatively, will privilege cognitive decision making.
• The authors posit that for immediate decisions concerning high-probability gains, ambiguity aversion is present, but for low-probability gains, ambiguity aversion or a weak preference for ambiguity emerges. If the resolution of the prospects is delayed, then ambiguity aversion towards high-probability gains will be reduced, with no effect on low-probability gains.
• Priming subjects to adopt a cognitive decision-making style will reduce ambiguity aversion for high-probability prospects. Alternatively, for temporally distant prospects, priming subjects to use an affective style will increase ambiguity aversion for the high-probability prospects.
• In a series of three web-based urn-problem surveys, the authors find support for their hypotheses.
Cass R. Sunstein, “People Prefer System 2 Nudges (Kind Of),” July 19, 2016. Duke Law Journal, Vol. 66, 2016. [The outline here is based on an earlier version, that of February 19, 2016.]
• In Kahneman’s terminology, System 1 is the automatic, intuitive part of our decision making, whereas System 2 represents our more considered (though not necessarily better) thoughts.
• Some types of nudges, such as graphic labels on cigarette packages or the selection of defaults, tend to be aimed at affecting System 1 responses. Other nudges, such as the provision of better information on nutrition, engage with System 2. System 2 nudges help people “exercise their own agency [p. 5],” that is, make better considered decisions.
• Sunstein arranges for a survey to be administered to seven groups of Americans, with more than 400 people in each group; they are paid for their participation.
• The participants are presented with four issues -- savings, smoking, clean energy, water -- and two alternative approaches, one System 1 nudge and one System 2 nudge, for each of the issues. The majority tends to prefer System 2 nudges, but a sizeable minority feels the other way. Democrats seem slightly more likely than Republicans to support System 1 nudges.
• If told that the System 1 nudge is significantly more effective, about 12% of folks switch to preferring the System 1 nudge; precise quantitative evidence of superior effectiveness does not seem to increase any further the attractiveness of System 1 nudges. When folks are told that System 2 nudges are more effective, that information has no effect on overall preferences between the options.
• Sunstein also explores a second set of three, more ideologically charged issues: voter registration, childhood obesity, and abortion. For voter registration and anti-obesity, a majority favor System 1 nudges. For dissuading abortions, most people prefer System 2 nudges, even when System 1 (show fetus photos) is said to be more effective.
• Alternatively, some people like System 1 nudges, even when they are told that those nudges are less effective. It seems that when people feel strongly about an issue, they support System 1 nudges that push their side of the issue.
• Sunstein makes a meta-observation, that perhaps our brain's System 1 likes System 2 nudges, but sometimes System 2 overrides that preference. Note that often System 1 nudges are fairly easy to implement, such as by setting a default, for instance.
Daniel Kahneman, “Experienced Well-Being.” Chapter 37, pages 391-397, in Thinking, Fast and Slow, New York: Farrar, Straus and Giroux, 2011.
• “Happiness” conflates experienced utility with remembered utility. Questions about subjective well-being probably do not map well with experienced utility. In a previous chapter (chapter 35, pages 377-385), Kahneman indicates that people’s memories of a past event tend to neglect the duration of the event (which is quite important as the event is being experienced), and that their assessment of a past event primarily will reflect the average of the peak level (of pain, say, for an aversive episode) and the state at the end of the event.
• How to measure experienced, moment-by-moment, utility? One method (“experience sampling”) is to interrupt people at random times throughout the day, and to ask them what they are doing and how they are feeling about it. The Day Reconstruction Method provides another measure, where people are asked to map in detail their previous day’s activities, and their emotional state at the time of the activities.
• The U-index measures the proportion of time people spend in an unpleasant state. The U-index exhibits significant variance: “a small fraction of the population does most of the suffering [p. 394].”
• You probably can improve your personal U-index by switching your leisure pursuits away from passive forms (watching television) to active forms (socializing).
• Policy might be able to reduce the overall U-index, perhaps by encouraging socializing for elderly people or by reducing commuting times. A small decrease in the percentage of time spent in an unpleasant state is quite significant in terms of suffering averted.
• Poverty can bring unhappiness, but money does not add to experienced well-being for household incomes above $75,000.
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.
Daniel Kahneman, “Anchors.” Chapter 11, pages 119-128, in Thinking, Fast and Slow, New York: Farrar, Straus and Giroux, 2011.
• Anchoring occurs when a person considers one number, before estimating another, unknown number. The estimate will tend to stay close to the original number considered, even if that original number is known to be completely unrelated to the estimated quantity.
• Anchoring might result from two (separate?) mechanisms. One is priming, the power of suggestion, which works on our rapid responses (“System 1”); the second is when we deliberate (“System 2”) over the estimate by adjusting away from the anchor, but do not adjust sufficiently.
• The asking price for a house can be a form of anchor – one that affects professional real estate agents as well as amateurs. The amount of damages requested in a civil suit also might serve as an anchor. Further, legislated maxima (caps) on damage awards might serve as an anchor, drawing upwards what otherwise might have been smaller awards.
• Instructions to deliberately counter the anchor can be effective.
Daniel Kahneman, “Prospect Theory.” Chapter 26, pages 278-288, in Thinking, Fast and Slow, New York: Farrar, Straus and Giroux, 2011.
• Outcomes (the carriers of utility) often seem to be associated with gains or losses relative to some reference point, not to overall states of wealth. Many people can’t generate a precise estimate of their wealth.
• Consider choosing between the prospects (+$900; 1) and (+$1000, $0; .9, .1). They have the same expected value, but we would expect that most people would choose the certainty of gaining $900 to the risky option.
• Now consider choosing between the prospects (-$900; 1) versus (-$1000, $0; .9, .1); many people would choose the risky prospect over the certainty of losing $900. People who are risk averse with respect to gains become risk loving with respect to losses.
• In physical sensations and in many other ways we respond to differences from a reference point. Is a bowl of water warm? The answer depends on the environment, holding the temperature of the water constant.
• Might loss aversion be an evolutionary adaptation, in that threats to the status quo are more urgent than are improvements?
• Consider the prospect (+$x, -$100; .5, .5); how much does x have to be for you to be willing to accept this gamble? For most people, it is between $150 and $250, indicating a “loss aversion ratio” of 1.5 to 2.5.
• Prospect theory ignores anticipated disappointment and regret, though these seem to matter in many actual choices.
Cass Sunstein, “If Misfearing is the Problem, is Cost-Benefit Analysis the Solution?” Chapter 13, pages 231-242, in The Behavioral Foundations of Public Policy, Eldar Shafir, editor, Princeton: Princeton University Press, 2013.
• The usual rationale for cost-benefit analysis (CBA) is that it promotes economic efficiency; nevertheless, perhaps the better argument for CBA is that it allows improved responses to the mis-fears of the public.
• The idea is that CBA is sort of a System 2 check on System 1 errors, to employ the terminology of Kahneman.
• People can misfear for multiple reasons, including the availability heuristic, informational cascades, excessive insensitivity to changes in probabilities, and the tendency to think that high-risk activities also involve small benefits.
• CBA is built around willingness-to-pay (WTP). But isn’t it the case that WTP depends on perceptions of risks and benefits, so that WTP itself might be the product of misfearing? Can we take preferences as given in conducting a CBA, or do we have to recognize that preferences and perceptions can be shaped?
• “Incompletely theorized agreements” are possible (and common?), where people can pragmatically agree upon a policy even though they have separate (and incompatible?) reasons for supporting the policy.
