How Can Behavioral Economics Help

Economic Educators?
Prof. Michael Staten
Director, Take Charge America Institute
Norton School of Family and Consumer Sciences

2013 Midwest Economic Education Conference
Kansas City, MO May 23, 2013

Economics and Behavioral Economics
Economics: the study of choices under conditions of
scarcity
• 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

Economics and Behavioral Economics
Economics: the study of choices under conditions of
scarcity
• 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 isn’t intended to throw out the Standard Economic Model,
just improve the accuracy of its predictions

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

Simple Example: Which Line is Longer?

Anchoring Bias (From Kahneman and Tversky.250 Correct answer = 40. 1974) Estimate the following product.320 . after it is displayed for 5 seconds: Display Option 1: 1x2x3x4x5x6x7x8 = ? Display Option 2: 8x7x6x5x4x3x2x1 = ? Mean estimates for Option 1 = 512 Mean estimates for Option 2 = 2.

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 .

youtube.Mental Accounting Dustin Hoffman and Gene Hackman on mental accounting • http://www.com/watch?v=t96LNX6tk 0U .

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) .

Party? .Study vs.

markets. Personal Finance Needs Behavioral Insights • Most economic education gives people conceptual tools to understand how the world works (individuals. groups.As a special sub-area of Economic Education. front page of NY Times or WSJ) • The personal finance component of economic education focuses squarely on helping individuals to make better personal decisions • Financial capability is 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) .g. economies) – We typically measure our impact by knowledge gained. and elevation in students’ ability to analyze new scenarios (e..

.How Well Do Americans Understand Their Finances? .

D. or F on their financial knowledge Sources: FINRA 2010 Financial Capability Study. NFCC 2010 Consumer Financial Literacy Survey .Financial Capability Remains a Challenge • The financial profile of American consumers suggests the need for more and better 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 monthly expenses 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 knowledge 34% gave themselves a grade of C.

The Symptoms Aren’t Improving. 68% decline in median net worth of households headed by someone younger than 35 (1984 to 2009) . 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 is over 20% • Over past 25 years.

• 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 simple mnemonic 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 you postpone collecting on Social Security from age 62 to 70. mostly for reasons beyond their control (health or changes at work) Source: Employee Benefit Research Institute . • But.S. 47% of retirees surveyed in 2013 say they retired sooner than they had planned.Zoom In on a Particularly Troublesome Area: Retirement Savings in the U.

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(Sources: Pension. Home Equity. SS. Defined Contribution/other savings) • 42% of private sector workers (aged 25-64) have any pension coverage in their current job • Home Equity: 27.The Facts About Retirement Savings in the U. • Workers who have performed a retirement needs calculation are twice as likely as those who have not to expect they will need to accumulate at least $1 million in savings before retirement.5% of homeowners with a mortgage were underwater in December 2012 Source: Zillow • Only 24% of all workers have accumulated more than $100K in savings and investments as of 2013 (not including home equity and any pension plans) • 46% of workers say they’ve completed a retirement needs calculation • 40% of workers think they need to accumulate at least $500K by the time they retire to live comfortably.S. .

to shape behavior we’ve 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. the rational individual recalculates options to reach a decision . more exercise.Interventions to Bring About Population-Wide Behavior Outcomes (e. gasoline or cigarettes • Tax penalty for early withdrawal of retirement savings • In both cases. less smoking) • Traditionally.. too • Higher taxes on soft drinks.g. more savings. healthier diets.

Cognitive Model for Programs to Improve Financial Capability Education raises financial literacy Changes to attitudes/beliefs create new incentives to act Change in behavior increases financial capability .

Alternative Approach: Context Model for Programs to Improve Financial Outcomes (inspired by behavioral economics: capitalizes on automatic processes of judgment heuristics) Use choice architecture and presentation to frame options Individuals’ perceptual biases lead to (anticipated) decisions Change in behavior without changing minds .

• The “art” to this approach is figuring out the right info and how to convey it. In the hybrid version of the Context Model. . Give the cognitive brain enough ammunition to make the “right” choice.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 optin to be liable for bank overdraft fees on debit cards. Behavioral Nudges can be informational (right info at the right time) • Provide specific information that clarifies the impact of an individual’s decision.

Contents and Calories .Three Factors to Consider: Cost.

Electric Power Consumption: Translate the Meter into $ .

Electric Power: Peer Comparison Appeals to Competitive Urge (or Guilt) .

Credit Score and Distributional Info .

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 balance – and the total interest cost – if 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 Do We Need a Nudge?) • When we see the benefits of an action now but the costs later (or costs now and benefits down the road) • When encountering decisions we make infrequently .e..When Is the Context Model Especially Effective? (i.

Remember Completing Forms Like This? .

When Is the Context Model Especially Effective? (i..e. or estimate likelihoods . When Do We Need a Nudge?) • When we see the benefits of an action now but the costs later (or costs 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.

what can we draw from behavioral economics to incorporate 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 why they are helpful • Watch for online “behavioral time machine” tools to help connect our present self with our future self . We Are Committed to the “Cognition” Approach So.As Economic Educators.

tangible) – Story Telling in Advertising Status Quo Bias People tend not to change an established behavior unless the incentive to change is compelling – try it for free.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 people’s 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. cancel later .

A wine list pricing strategy – low end .

A wine list pricing strategy – low end .

cancel later .Three easy ways to be tricked in the marketplace Framing Effect Presenting the same thing in different forms can alter people’s 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 your armchair) Status Quo Bias People tend not to change an established behavior unless the incentive to change is compelling – ry it for free.

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cancel later .Three easy ways to be tricked in the marketplace Framing Effect Presenting the same thing in different forms can alter people’s decisions – 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 (hypothetical vs. some firms urge you to try it for free. tangible) – Story Telling in Advertising Status Quo Bias People tend not to change an established behavior unless the incentive to change is compelling – So.

Lesson #1 Being aware of these behavioral tendencies can help people make spending decisions they are happier with in the long run .

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 timehorizons • Planner tries to shape the long-term environment • Doer is the producer…in addition to living in the moment as the consumer .

Physical Fitness Choices: gym memberships Calendar commitments Credit Card Behavior: carrying balances when you tell yourself you are going to pay it off (but don’t) • Saving (for college/vacation/retirement etc.): start today vs.Individual Inconsistency is often the result of Planner/Doer conflict Present bias or Dynamic Inconsistency: What is preferred at one point in time is inconsistent with what is preferred at another point in time • Can be more problematic for younger people (Future self-continuity and steeper temporal discounting) • Examples • • • • Current snack vs. tomorrow . future snack: chocolate or fruit.

” Nassau W. 1836 – http://www.youtube. or to seek distant rather than immediate results. Senior. are among the most painful exertions of the human will.com/watch?v=W-Cz-LK16g4 Lesson #2 – An unchecked “doer” can make a person miserable .Present Self and Future Self “To abstain from the enjoyment which is in our power.

some employers automatically sign people up for retirement savings upon employment.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 (healthier food choices) • Automatic deduction from paycheck for regular savings accumulation • Saving for retirement with automatic 401K contributions In response to these tendencies. The individual has the option of opting out. Combined self-disclosure and pre-commitment tools are gaining popularity by harnessing social networking .

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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 .

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 .Behavioral Time Machine Tools: Connect present self with future self (good reference: Daniel Goldstein.

Behavioral Time Machine Tools .

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 help connect our present self with our future self .

Gary Belsky and Thomas Gilovich The Battle Between Your Present Self and Future Self. 2008 The Marketplace of Perceptions. and happiness. Sunstein. 2008 Don’t stop thinking about tomorrow: Individual differences in future self-continuity account for saving. Richard H. TED talks. Thaler and Cass R. Judgment and Decision Making. December 2011 Thinking. Harvard Magazine.Additional Reading Nudge: Improving decisions about health. Daniel Goldstein. et al.Hershfield. Daniel Kahneman. wealth. Dan Ariely. Fast and Slow. 2009 Why Smart People Make Big Money Mistakes and How to Correct Them: Lessons from Life-Changing Science of Behavioral Economics. April 2006 Predictably Irrational: The Hidden Forces that Shape our Future. Hal Ersner. 2011 .