Behavioural

Question 1

How analyse welfare if agents not rational and selfish?

Answer 1

• positive models of behaviour (e.g. hyperbolic discounting)

- develop bounds on welfare (based on observed choices)

Question 2

Key deviations from homo economicus?

Answer 2

• social preferences
• bounded rationality
• bounded willpower/impatience/procrastination
• reference-dependent preferences

Question 3

Type of discounting if individuals ARE time consistent?

Answer 3

Exponential

Question 4

Type of discounting if individuals are NOT time consistent?

Answer 4

Hyperbolic

Question 5

Discount factor between current period and future period w/hyperbolic discounting?

Answer 5

Beta * Delta (to the power of whatever time period it is)

Question 6

Discount factor between 2 future periods w/hyperbolic discounting?

Answer 6

Delta

Question 7

Theories about which discount factor to use in welfare calculations?

Answer 7

• Long-run preferences (Beta = 1 and Delta < 1, i.e. exponential, not hyperbolic, discounting)
• Short-run actual preferences (even if that means hyperbolic discounting)
• Multiple selves (implication - focus on long-run self)

Question 8

Explain the idea of multiple selves (in terms of discount factor to use for welfare calculations)

Answer 8

• long-run self (the ‘planner’) w/discount factor delta
• series of short-run selves (‘doers’) that live for 1 period and are totally myopic (discount factor gamma = 0)
• long-run self sets incentives for short-run selves
• short-run selves choose action, given incentives
• short-run selves are the only selves that derive utility
• utility of long-run self = discounted sum of utilities of all short-run selves

WELFARE IMPLICATION - FOCUS ON LONG-RUN SELF

Question 9

1. What is an ancillary condition in Bernheim and Rangel’s (2009) bounds model?
2. Example?

Answer 9

1. Affects choice behaviour, but not experienced utility

2. e.g framing, salience

Question 10

Broad types of possible intervention if people suffer from behavioural biases?

Answer 10

1. paternalism (direct regulation)

2. behaviouralism (nudges)

Question 11

….. and ….. (….) created a model to derive bounds on welfare using revealed preferences

Answer 11

Bernheim and Rangel (2009) created a model to derive bounds on welfare using revealed preferences

Question 12

1. Problem of ‘looseness of bounds’ on welfare
2. Solution?
3. Evaluate solution

Answer 12

1. Problem - if behavioural issues important (e.g. framing, salience), then bounds so ‘loose’/wide that they become uninformative

2a. Solution - discard certain d’s as being ‘contaminated’ for welfare analysis
2b. e.g. intoxication reduces rationality so discard choices made when drunk
2c. Fewer d’s means tighter bounds on welfare

3. Problem – refinements require positive theory of behaviour…(original problem!)

Question 13

Outline Bernheim and Rangel’s (2009) model for deriving bounds on welfare

Answer 13

1. Standard models: agents choose x (from choice set X)
2. Behavioural models: agents choose (from generalised choice set G, where G = (x,d))

3a. ‘d’ = ancillary condition (affects choice behaviour, but not experienced utility)
3b. d could be framing, salience, default option

4. Revealed preference: prefer x over y, if x always chosen over y FOR ANY D

Question 14

Provide simple example of deriving bounds on welfare using revealed preferences

Answer 14

1. Example – car insurance (3 different plans: 1, 2 and 3)
2. Run 2 experiments (experiment A and B could represent different framings of survey, or different salience of options)

3a. Preferences in experiment A: 1 > 2 > 3
3b. Preferences in experiment B: 2 > 1 > 3

4. Plan 3 never optimal for all d (whatever the ancillary condition is, e.g. framing), regardless of positive theory, so optimum bounded between 1 and 2

Question 15

Chetty et al (2009)

Answer 15

AFFECT OF TAX SALIENCE

1. Experiment:

(i) Vary salience of sales tax
(ii) Including sales tax of 7.35% in displayed price decreases demand by ~8%

2. Empirical analysis:

(i) Exploit state-level changes in excise/sales taxes
(ii) US consumers more responsive to increase in excise duty on alcohol (included in displayed price) than sales tax (not included in displayed price)

Question 16

Chetty et al (2009)

1. Experiment:

(i) Vary salience of sales tax
(ii) Including sales tax of …..% in displayed price decreases demand by …..%

2. Empirical analysis:

(i) Exploit state-level changes in excise/sales taxes
(ii) US consumers more responsive to increase in ….. (included in displayed price) than ….. (not included in displayed price)

Answer 16

Chetty et al (2009)

1. Experiment:

(i) Vary salience of sales tax
(ii) Including sales tax of 7.35% in displayed price decreases demand by ~8%

2. Empirical analysis:

(i) Exploit state-level changes in excise/sales taxes
(ii) US consumers more responsive to increase in excise duty on alcohol (included in displayed price) than sales tax (not included in displayed price)

Question 17

Experimental evidence that consumers are more responsive to changes in more salient taxes

Answer 17

Chetty et al (2009)

Experiment:

(i) Vary salience of sales tax
(ii) Including sales tax of 7.35% in displayed price decreases demand by ~8%

Question 18

Welfare analysis with salience effects - preference recovery assumptions

Answer 18

(1) taxes affect utility only through effects on chosen consumption bundle
(2) when tax inclusive prices fully salient, agent chooses same allocation as fully-optimising agent

Question 19

1. If tax salience affects behaviour, how might a less salient tax be more efficient?
2. Under what assumption?

Answer 19

1. Less salient tax affects behaviour less, leading to smaller fall in consumption and lower DWL
2. Assumption = no income effects (dx/dz = 0)

Question 20

1. Under what assumption might a less salient tax decrease efficiency (if salience affects behaviour)?
2. Example?

Answer 20

1. Assumption = income effects (dx/dz > 0)

2. Agent who ignores complex tax on cars might under-consume food due to income effect (lowering welfare)