Auto-suggest suggests how far behavioral economics has come, and how far it still has to go

In terms of recognition and respect, behavioral economics has certainly come a long way in the last 25 years. But it is still a Hibernian outpost in the great Roman Economics empire. One of the newest metrics for evaluating its impact is the auto-suggest feature in many search engines that has become quite popular since Google aired its ode to the long-distance romance during the Super Bowl.

In order to compare regular economics and behavioral economics, the Nudge blog typed in the first word of a few major concepts from each field into Google.

From economics, there is “supply and demand,” “opportunity cost,” and “economies of scale,” all of which appear to be quite popular. Notice that the phrases themselves are popular, as well as ones that add “examples” to the end of the phrase.

From behavioral economics, there is “prospect theory,” “endowment effect,” and “bounded rationality.” The first two still have a ways to go before becoming part of everyday parlance. Bounded rationality, on the other hand, looks potentially well positioned to make it. Of course, how many phrases out there start with “Bounded”? More or less than phrases that have “ou” as the second and third letters in the first word? (That’s a behavioral economics special for all the careful readers out there.)

If you’re selling a house, ask your realtor to list it as a range

Says Psychology Today.

One advantage is obvious: Buyers scanning listings online usually set a minimum and maximum price. These are round numbers (often chosen from a menu on the listing site). In the example above, a buyer whose maximum price was $1 million would see a house listed at “$999,000 to $1,194,876,” but not a house listed at a single price higher than a million. (Of course, this depends on listing sites being able to handle price ranges.)

Another advantage of this trick is simple confusion. Just about everyone knows that a listing price of $X typically signals that the seller is willing to accept a good deal less than $X. In this market, few sane buyers are going to offer list price. Having two prices upsets this comfortable strategy. Do you offer the low price of the range? Less than the low price? Or do you make an offer somewhere in the range? Maybe you really, really want the house and want to make a preemptive offer. Do you offer the high price?

This suggestion still doesn’t get around the problem inherent in the behavioral economics diagnosis of the current housing market. Loss averse sellers don’t want to sell a property for less than they paid for it, or less than what they think it’s worth based on peak bubble prices. Whether she picks a range or a single price, the seller has to overcome the psychological hurdle or realizing that the value today isn’t the value yesterday.

The origins of economics

Richard Thaler, speaking recently at a World Economic Forum panel.

“Let’s go back to Adam Smith,” Mr. Thaler suggested on a high-profile panel on Rebuilding Economics. “No, actually, let’s go back to Adam.”

“When it was just the demand for apples, the model still worked pretty well,” he said. “But today we have Apple and the iPhone pricing strategy.”

“Adam could deal with apples — as long as there were no serpents and women,” Mr. Thaler added. “When you add serpents and women, you get self-control problems that the model cannot deal with.”

Sendhil Mullainathan on behavioral economics and the hardest social problems

MacArthur winner and Harvard behavioral economist Sendhil Mullainathan talks about a tricky set of social problems — those we know how to solve, but don’t. We know how to reduce child deaths due to diarrhea, how to prevent diabetes-related blindness and how to implement solar-cell technology … yet somehow, we don’t or can’t. Why?

The illusion of progress

This month’s Capital Ideas, published by the University of Chicago Graduate School of Business, features work done by our colleague Oleg Urminsky on the relationship between rewards and human efforts and motivations. The classic work on this puzzle was conducted in the 1930s by psychologist Clark Hull who noticed that rats ran faster as they moved closer to food. (Food they could see on a straight runway, that is.) Sensing the propinquity of the reward, the rats worked harder to obtain it. Hull called this phenomenon the “goal-gradient” hypothesis.

Urminsky, along with Ran Kivetz of Columbia University and Yuhuang Zheng of Fordham University, turned their attention to customer reward programs to further study Hull’s hypothesis, by analyzing how the distance to a final reward affected customers’ purchasing decisions.

Continue reading the post here.

More on behavioral economics and social security

Peter Orszag responds to yesterday’s post about the relevance of penalties on wage earnings before reaching full employment age – also known as the retirement earnings test.

It is true that if people don’t understand how the retirement earnings test (RET) works, knowing that it no longer applies starting at the full benefit age could cause some people to claim at that age. (Those who do understand the RET know that the recalculation that occurs when a beneficiary subject to the RET reaches the full benefit age compensates them for the benefits offset while they were still working – again making the benefit actuarially fair).

Continue reading the post here.

Behavioral economics patterns in social security?

From a speech last week by Congressional Budget Office Director Peter Orszag at the Retirement Research Consortium:

Distribution of the Age at Which Primary Beneficiaries Claim Social Security Benefits by Birth Year

Continue reading the post here.

A classic is back – cash discounts and credit surcharges

Last month USA Today said gas stations were bringing back the cash discount. Indeed they were. The Nudge blog shot this picture at a Shell station in northern Virginia today.

The regular price was $3.99 a gallon. USA Today makes no mention of why gas stations are advertising a cash discount instead of a credit card surcharge – an old retailing trick – but good behavioral economists know the answer. Humans view discounts differently from surcharges. The first is an opportunity cost; the second a cost outlay. In Toward a Positive Theory of Consumer Choice, Thaler wrote:

Until recently, credit card companies banned their affiliated stores from charging higher prices to credit card users. A bill to outlaw such agreements was presented to Congress. When it appeared likely that some kind of bill would pass, the credit card lobby turned its attention to form rather than substance. Specifically, it preferred that any difference between cash and credit card customers take the form of a cash discount rather than a credit card surcharge. This preference makes sense if consumers would view the cash discount as an opportunity cost of using the credit card but the surcharge as an out-of-pocket cost.

In Choices, Values, and Frames, Kahneman and Tversky argued that the distinction is one of framing. The discount is seen as a gain while the surcharge is seen as a loss. Since humans are loss averse, we are more likely to give up the discount (the gain) than accept the surcharge (the loss).

The fact that the cash discount is applied to gas provides an interesting wrinkle to the original credit card discussion which ignored the good itself. The sharp increase in the price of is especially painful to loss averse humans whose purchasing power at the pump has slipped considerably. Filling up anywhere, with cash or credit, feels like a raw deal. On a good like this, does the gap between those who forgo the discount and those who pass shrink? In other words, if a pair of a jeans and a gallon of gas both have the same cash discount on a percentage basis, would the number of people taking each be similar?

Behavioral economics and standing in line outside indymac

Since the Great Depression, the U.S. government has insured bank deposits up to $100,000 per account. So why, last week, were so many people standing in line at IndyMac, the California bank that failed under the crush of bad subprime loans? Fear, uncertainty, loss aversion, a propensity for herd behavior – behavioral economists have seen this all this before. A seminal paper on herd behavior in non-market contexts (Banerjee 1992) argued that herd behavior can occur when private information is not shared publicly. Individuals with private information act, leading to information cascades as others follow their lead, with the result being a socially suboptimal outcome.

In the case of IndyMac, no one had – or has – any private inside information about the collapse of the Federal Deposit Insurance Corporation, and yet public notices about bank deposit insurance did not keep people at home. Of course, everyone in line might have simply wanted enough money to pay a mortgage and food for a month, or had assets greater than $100,000, which meant all of their money wouldn’t have been insured. But what are the odds?

The Washington Post points out an interesting distinction between how people see the failures of human institutions like IndyMac versus the physical destruction caused by natural events like hurricanes.

People are often more fearful of man-made events than they are of natural ones. “We are rather blase about nature,” said Paul Slovic, the founder of Decision Research, an Oregon nonprofit group that studies human behavior and advises governments. “We think it’s generally benign even though we get clobbered by it over and over again. That’s why after a big storm we go back and rebuild on the spot.”

He continued: “But we are quite the opposite for certain types of risk that are human-caused, particularly if they involve something new or mysterious. We react very strongly to that. . . . If people see signs of incompetence or that the system is not being regulated or controlled, that is very worrisome.”