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 isnt 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, 1974)

Estimate the following product, 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 = 2,250
Correct answer = 40,320

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

Mental Accounting

Dustin Hoffman and Gene Hackman on mental

accounting

http://www.youtube.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)

Study vs. Party?

As a special sub-area of Economic Education,

Personal Finance Needs Behavioral Insights
Most economic education gives people conceptual tools to
understand how the world works (individuals, groups,
markets, economies)
We typically measure our impact by knowledge gained, and elevation
in students ability to analyze new scenarios (e.g., 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)

How Well Do Americans Understand Their

Finances?

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,D, or F on

their financial knowledge

Sources: FINRA 2010 Financial Capability Study, NFCC 2010 Consumer Financial Literacy Survey

The Symptoms Arent Improving, 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, 68% decline in median net worth of
households headed by someone younger than 35 (1984 to
2009)

Zoom In on a Particularly Troublesome Area:

Retirement Savings in the U.S.
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.

But, 47% of retirees surveyed in 2013 say they retired sooner

than they had planned, mostly for reasons beyond their control
(health or changes at work) Source: Employee Benefit Research Institute

The Facts About Retirement Savings in the U.S.

(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: 27.5% 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 theyve completed a retirement needs calculation

40% of workers think they need to accumulate at least $500K by the

time they retire to live comfortably.

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.

Interventions to Bring About Population-Wide

Behavior Outcomes
(e.g., more savings, healthier diets, more exercise, less smoking)

Traditionally, to shape behavior weve 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, too
Higher taxes on soft drinks, gasoline or cigarettes
Tax penalty for early withdrawal of retirement savings

In both cases, the rational individual recalculates

options to reach a decision

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

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.
In the hybrid version of the Context Model, Behavioral Nudges
can be informational (right info at the right time)
Provide specific information that clarifies the impact of an
individuals decision. Give the cognitive brain enough
ammunition to make the right choice.
The art to this approach is figuring out the right info and
how to convey it.

Three Factors to Consider:

Cost, Contents and Calories

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

When Is the Context Model Especially Effective?

(i.e., 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

Remember Completing Forms Like This?

When Is the Context Model Especially Effective?

(i.e., 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, or estimate
likelihoods

As Economic Educators, We Are

Committed to the Cognition Approach
So, 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

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 peoples 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. 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, cancel later

A wine list pricing strategy low end

A wine list pricing strategy low end

Three easy ways to be tricked in the

marketplace
Framing Effect
Presenting the same thing in different forms can alter peoples 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, cancel later

Three easy ways to be tricked in the

marketplace
Framing Effect
Presenting the same thing in different forms can alter peoples 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. tangible)
Story Telling in Advertising

Status Quo Bias

People tend not to change an established behavior unless the incentive to
change is compelling
So, some firms urge you to try it for free, cancel later

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 producerin addition to living in the moment as the
consumer

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. future snack: chocolate or fruit,

Physical Fitness Choices: gym memberships
Calendar commitments
Credit Card Behavior: carrying balances when you tell yourself you
are going to pay it off (but dont)
Saving (for college/vacation/retirement etc.): start today vs.
tomorrow

Present Self and Future Self

To abstain from the enjoyment which is in our power,
or to seek distant rather than immediate results, are
among the most painful exertions of the human will.
Nassau W. Senior, 1836
http://www.youtube.com/watch?v=W-Cz-LK16g4

Lesson #2 An unchecked doer can make a

person miserable

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, some employers automatically sign
people up for retirement savings upon employment. The individual
has the option of opting out.

Combined self-disclosure and pre-commitment tools are

gaining popularity by harnessing social networking

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

Behavioral Time Machine Tools:

Connect present self with future self
(good reference: Daniel Goldstein, 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

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

Additional Reading
Nudge: Improving decisions about health, wealth, and happiness,
Richard H. Thaler and Cass R. Sunstein, 2008
The Marketplace of Perceptions, Harvard Magazine, April 2006
Predictably Irrational: The Hidden Forces that Shape our Future, Dan
Ariely, 2008
Dont stop thinking about tomorrow: Individual differences in future
self-continuity account for saving, Hal Ersner- Hershfield, et al,
Judgment and Decision Making, 2009
Why Smart People Make Big Money Mistakes and How to Correct
Them: Lessons from Life-Changing Science of Behavioral Economics,
Gary Belsky and Thomas Gilovich

The Battle Between Your Present Self and Future Self, Daniel Goldstein,
TED talks, December 2011
Thinking, Fast and Slow, Daniel Kahneman, 2011