Tag Archives: behavioral economics

Enough

By James Kwak

A friend passed on this article in The Motley Fool by Morgan Housel. It begins this way:

Enough.

“That’s the title of Vanguard founder John Bogle’s fantastic book about measuring what counts in life.

“The title, as Bogle explains, comes from a conversation between Kurt Vonnegut and novelist Joseph Heller, who are enjoying a party hosted by a billionaire hedge fund manager. Vonnegut points out that their wealthy host had made more money in one day than Heller ever made from his novelCatch-22. Heller responds: ‘Yes, but I have something he will never have: enough.'”

The rest of the article discusses the cases of Rajat Gupta and Bernie Madoff, the former accused (but not criminally) and the latter convicted of illegal activity done after they had already been enormously successful, professionally and financially.

Housel asks, why do people push on — legally or illegally — when they have more of everything than anyone could possibly need? He summarizes the happiness research as follows:

“Money isn’t the key to happiness. What really gives people meaning and happiness is a combination of four things: Control over what they’re doing, progress in what they’re pursuing, being connected with others, and being part of something they enjoy that’s bigger than themselves.”

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No No No! It’s Already Priced In!

By James Kwak

That was undoubtedly the response of theoretical law and economics devotees to the premature retirement of Kansas City Royals pitcher Gil Meche a few weeks ago, which we discussed in one of my classes last week. Meche signed a five-year, $55 million, guaranteed contract before the 2007 season, which would have paid him $12 million in 2011 simply for showing up, despite a broken-down shoulder that made him an ineffective pitcher. Yet Meche decided to retire, giving up the $12 million. Meche said this:

“Once I started to realize I wasn’t earning my money, I felt bad. I was making a crazy amount of money for not even pitching. Honestly, I didn’t feel like I deserved it. I didn’t want to have those feelings again.”

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Is Happiness Conservative?

By James Kwak

A few days ago I wrote a post addressing Mike Konczal’s question of whether behavioral economics, as a whole, weakens the case for the welfare state or, more generally, for activist liberal policies. I said the answer was “no.” But I think positive psychology—otherwise known as happiness research—presents a more difficult question.

I’ve only consumed popular versions of happiness research, such as The Happiness Hypothesis, by Jonathan Haidt, but basically the story is something like this. For much of its history, psychology had a pathological bent: it was concerned with figuring out why people had psychological problems and how to cure those problems. (Whether it had any success whatsoever is a question for another day and another blog.) A few decades ago, however, some psychologists decided they would try to figure out what makes people happy, and they started a wave of happiness studies that continues today. In many of these studies, people are pinged at random times and asked to rate how happy they are at that moment. Then treatments are introduced so you can measure the difference in happiness between the treatment and control groups. For example, if people find a quarter in a pay phone,* afterward they will report they are happier than people who didn’t find the quarter; not only does this effect persist for a surprisingly long time (into the next day, I think), but also affects people’s reported happiness about unrelated parts of their life, like their family life.

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Does Behavioral Economics Undermine the Welfare State?

By James Kwak

That’s the title of a post by Mike Konczal, who answers it in the negative. The question comes from Karl Smith and is based on a paper by Bryan Caplan and Scott Beaulier. The paper argues that welfare programs expand the set of choices available to people; while that is all good according to traditional economics, if we think that people are inclined to make bad choices (“behavioral economics”), then welfare programs give people more opportunity to make bad choices and hurt themselves. This is particularly a problem because, they claim, “there are good empirical reasons to think that behavioral economics better describes the poor than it does the rest of the population” (p. 4). In other words, if poor people are more irrational, then giving them more choices will hurt them more than other people.

Let’s start with that last claim. What could it even mean that “[some academic subfield] better describes [one group of people] than it does the rest of the population”? It seems to me there’s a category error here. Behavioral economics describes human beings, and the major population used in most experiments is undergraduates at prestigious universities. If the findings of the research are biased in any way, that’s the bias.

But what Caplan and Beaulier really mean to say is this: “Existing literature provides good reasons to think that the deviations of the poor from the standard neoclassical model are especially pronounced.  Their judgmental biases are more extreme, and their self-control problems more severe, than those of the rest of the population” (p. 12). So basically they boil down all of behavioral economics to the proposition that people behave irrationally (admittedly, this is what is most prominent in the popular literature), and then they say that the poor are more irrational than “normal” people. (The normative standpoint is theirs, not mine. Check out this clause: “deviant behavior is much more pronounced among the poor.”)

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Mittens or Dinner?

By James Kwak

Although I have written many blog posts pointing out that people are not actually rational maximizers (that is, they don’t know what their preferences are, and even if they did they don’t make rational choices to maximize those preferences), I actually try to be a rational maximizer as much as possible. That is, when making decisions, I try to think about what my expected utility (admittedly, some vague combination of immediate happiness, reflective happiness, reduction in stress, and increase in leisure time*) is from each course of action and decide accordingly. When I was working and very, very busy, this translated into the $25 rule: for personal stuff, I valued my time at $25 per hour.** So if I had to return something to the store, but it cost $10 and it would take me half an hour, I wouldn’t bother.

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What a Little Bit of Economics Does to You

By James Kwak

For a class, I read an old (1986) paper by Kahneman, Knetsch, and Thaler on fairness. It’s based on surveys posing various hypothetical situations where businesses can take some action. For example, most people thought that it was OK for a grocer to pass on a wholesale price increase to consumers (Question 7) but not to raise prices because there is a general shortage and the grocer has the only shipment of a certain item (Question 12). In short, people have an intrinsic sense of fairness the authors summarize this way: “The cardinal rule of fairness is surely that one person should not achieve a gain by simply imposing an equivalent loss on another.”

Today in class, the professor posed the first question from the paper:

“A hardware store has been selling snow shovels for $15. The morning after a large snowstorm, the store raises the price to $20.”

In 1986, 82 percent of respondents thought this was unfair. In class, it was about 50-50.

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They’re Just Irrational?

By James Kwak

Don’t get me wrong: I like behavioral economics as much as the next guy. It’s quite clear that people are irrational in ways that the neoclassical model assumes away, and you can’t see human nature quite the same way after hearing Dan Ariely talk about his experiments on cheating. But I don’t think cognitive fallacies are the answer to everything, and I don’t think you can explain away the myriad crises of our time as the result of them, as Richard Thaler does in his recent New York Times article.

Like many people, Thaler wants to write about the parallels between the financial crisis and the BP oil leak. For Thaler, the root cause of both crises is that “people in general are not good at estimating the true chances of rare events, especially when human error may be involved” — catastrophic market seizures in the first case, catastrophic oil rig explosions in the latter case.

I have no doubt that it is true that people have problems estimating the chances of certain rare events.* But to stop there is to whitewash the sins of the companies and the executives who created these crises.

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When a Nudge Becomes a Shove

Richard Thaler, co-author of Nudge, wrote an op-ed in The New York Times this weekend arguing that we should change the default option for organ donation. Reading the article helped crystallize for me a vague concern I’ve had with all this behavioral economics-inspired, benevolent-paternalistic behavior modification that has gotten so much attention lately among the smart set. But I’m getting ahead of myself.

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Krugman on Economics

This weekend’s New York Times Magazine has the 7,000-word article about the state of macroeconomics that Paul Krugman has been hinting at for some time now. It’s a well-written, non-technical overview of the landscape and the position Krugman has been presenting on his blog, which for now I’ll just summarize for those who may not have the time to set aside just now.

Like many, Krugman faults the discipline for its infatuation with mathematical elegance:

“[T]he central cause of the profession’s failure was the desire for an all-encompassing, intellectually elegant approach that also gave economists a chance to show off their mathematical prowess.

“Unfortunately, this romanticized and sanitized vision of the economy led most economists to ignore all the things that can go wrong. They turned a blind eye to the limitations of human rationality that often lead to bubbles and busts; to the problems of institutions that run amok; to the imperfections of markets — especially financial markets — that can cause the economy’s operating system to undergo sudden, unpredictable crashes; and to the dangers created when regulators don’t believe in regulation.”

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Is It Possible to Detect Bubbles?

On the one hand, it seems obvious; didn’t we all know there was a housing bubble back in 2006? On the other hand, if it’s that easy, why aren’t we all as rich as John Paulson?

A while back I suggested that the Fed could spot a housing bubble by treating housing prices the same way if treats the prices that make up the CPI. If there is high inflation in the core CPI, you don’t stop and ask if there is a fundamental reason for higher inflation; you tighten monetary policy (raise interest rates). The Fed could do the same thing for housing prices, since housing is an asset that people need to consume. But that’s probably a simplistic view.

Leigh Caldwell thinks that behavioral approaches may be able to separate out irrational overvaluation from changes in fundamental values. I believe his argument is that you can measure the degree of irrational overvaluation for certain types of assets, and you can extrapolate from there to see if there is a bubble:

Outside of the laboratory, precise knowledge of the returns of some assets does become available at times, and it would be possible to measure investors’ behaviour with regard to those assets. If investors, in aggregate, become overconfident about returns it will be possible to spot this from certain types of price change.

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