Behavioural Economics

Question 1

What is Behavioural Economics?

Answer 1

Behavioral Economics is the Combination of psychology and economics that
investigates what happens in markets in which some of the agents display
human limitations and complications” (International Encyclopedia of the
Social and Behavioral Sciences)

Question 2

What does Behavioural Economics cover?

Answer 2

Studies human behaviour

Question 3

What is the standard approach to Behavioural Economics?

Answer 3

-Standard Approach - for any level of information, income and prices, consumer
behavior is determined by consumers’ preferences

◼ Consumers suffer no cognitive limitations, and no systematic bias

Question 4

What can Consumer Policies focus behaviourally?

Answer 4

Consumer policies should focus on providing accurate information (or education and advice)

◼ Regulation, subsidies, taxes should be used with caution

Question 5

How can we see the decisiveness of ‘ Irrelevant’ Factors?

Answer 5

1. Small changes can make big differences
2. Policies run against human nature may be ineffective
3. Behavioural biases may be exploited by firms
4. Behavioural biases may be used by governments (e.g. nudges)
5. Behaviourally Inspired Policies or Behavioural Public Policies:
6. Cost-effective
7. Liberty preserving (freedom of choice)
8. Widely supported

Question 6

What are the differing biases?

Answer 6

1. Availability bias
2. Status quo bias
3. Sunk cost fallacy
4. Endowment effect
5. Choice overload

Question 7

What is the Availability Bias?

Answer 7

Consumers are sensitive to perceived availability, or ease of retrieval (e.g.
time limited offers)

Question 8

What is the Status Quo bias?

Answer 8

Consumers consider deviations from reference points as a loss (e.g. the
preferred good)

Question 9

What is the Sunk Cost fallacy?

Answer 9

Consumers cannot disregard expenditures that have already occurred
(e.g. ski on a rainy day because of a prepaid lift ticket)

Question 10

What is the Endowment Effect?

Answer 10

Consumers value more the goods if they feel entitled to them, or
engaged with

Question 11

What is Choice Overload?

Answer 11

More information can be worse than less information

Question 12

What is the Basic Design of a randomised controlled trial (RCT)?

Answer 12

A trial in which subjects are randomly assigned to one of two groups: one (the experimental group) receiving the intervention that is being tested, and the other (the comparison group or control) receiving an alternative (conventional) treatment

Question 13

What is an example of the Endowment Effect?

Answer 13

Consumers tend to value (and pay) more for an item in one’s possession

◼ Richard Thaler’s experiment: Econ students at Cornell University in a market
◼ Ss on alternating seats were given a Cornell coffee mug or the chance of buying it

What does economic theory predict?
◼ Mug/pen haters should sell them to mug/pen lovers, same average value
◼ What did they observe?
◼ Mugs NOT traded
◼ Median value for sellers $5.25
◼ Median value for buyers $2.50

Question 14

What is the Anchoring Bias?

Answer 14

• Consumers make decisions by anchoring on an arbitrary reference value in the decision context?

Question 15

What can we see due to the Anchoring Bias?

Answer 15

-Asset prices reflect the market estimate of the discounted present value of the asset’s payoff stream

-Supply of labor is the outcome of the trade-off between the desire for consumption and
the displeasure of work

-Consumers demand good and services following the valuation of pleasures they anticipate

Question 16

What is the Framing Effect example?

Answer 16

◼ In September 2001, President Bush signed the ‘‘Economic Growth and Tax Relief
Reconciliation Act’’, and returned $38 billion to taxpayers in the form of $300–$600 ‘‘tax
rebates,’’
-But, only 22% of households planned to spend their rebate check

-Behavioural hypothesis: people may be more (less) likely to spend income framed as a gain or a bonus (returned loss, or a rebate) from a state

Question 17

What is the Reference Point/Contextual Factors Bias?

Answer 17

• People buy and sell based on the context behind the purchase

Question 18

What is the Sunk(Search) Cost?

Answer 18

-A tendency to continue a project (search) once an initial investment made

Example: WB staff randomly assigned to scenarios as task team leader

Manipulation: the proportion of funds already committed (30% or 70%)
Would you commit the additional funds? (Would others?)

Question 19

How can we see the Choice Overload in the real world?

Answer 19

-Individuals’ decisions should not be influenced by the introduction of additional options that would not otherwise have been selected

-Evidence suggests that large increases in the number of alternatives can induce individuals
to…
1)…refrain from selecting an option at all,
2) …prompt individuals to make a suboptimal decision,
3)…induce individuals to be more likely to pick default options.

• These phenomena are often referred to as ‘choice overload’ (or ‘deferred choice’, ‘choice
  avoidance’ and ‘paradox of choice’)