In the previous edition of Academic Bridge, we presented a note with 6 basic ideas that we assumed are present in the basic toolbox of an economist. Undoubtedly, the title was quite ambitious (why six and not seven? Why those concepts and not others?) and possibly subject to objections from other schools of thought, or even from other approaches or branches of economics. .
A quick example: In the media (and also in academia) greater importance is usually given to macroeconomic concepts, without greater connection with those of a micro nature, which are those that account for the decisions that people make.
But the problem is not that simple either, there is simply no single microeconomics. Precisely, one of the alternative approaches that has been gaining space through publications and empirical testing is what has been called behavioral economics. In this branch, a body of more realistic explanations about the effective behavior of economic agents are developed.
This contrasts with the mainstream that proposes the rational agent as a model; people who act based on calculations of optimal behavior, weighing costs and benefits of each economic decision they make. On the contrary, under behavioral assumptions, rationality loses ground in the domain of decisions, giving way to intuition, environmental influences, cognitive biases, endowments, status quo, self-control, values, learning processes, and more.
The interesting thing about this time is that the debate is open and in full construction between argument, counter-argument and proof. Furthermore, the concepts of microeconomics, since they deal largely with the factors that influence our decision-making processes, turn out to be more intuitive than macroeconomic phenomena.
1- For a sincere economist, everything has a cost... but our behavior tends to increase it
In the previous article, it was stated that “at the heart of economic analysis lies a decision.” What does this mean? That in a certain context, a decision made by an agent necessarily involves a comparison between at least two alternatives. In other words, when you choose to do “something,” you inevitably stop doing “something else.” Which? That best alternative that is given up when making a choice is called opportunity cost.
The opportunity cost of reading this note may be taking a nap. Unless you're using reading to fall asleep, in which case the alternative would be something else: let the article get interesting (maybe).
The existence of endowment effects, greatly complicates this calculation. In behavioral terms, the valuation that an agent makes of an asset changes whether or not it is his or her property. If something is mine, it is automatically worth more to me than to the market. By dint of being redundant, the endowment effect adds an extra value to the good of which an agent is the owner, which can no longer be valued by the price system. Given this asymmetry, the value calculation is disrupted, as an opportunity cost cannot be attributed to market prices.
It seems that Marie Kondo, the acclaimed order guru, has been able to very intelligently exploit the endowment effect. In the experiments that have been carried out to demonstrate the effect, it is shown that most people have the tendency to keep what they already have. Donating, throwing away or even selling something constitutes a loss; unless there is a strong reason to change.
In the case of reality show by Kondo, the reason to change is to achieve a more harmonious life. But Kondo's recipe does not consist of explaining conceptually or judging whether a certain family arranges its house disastrously or not. On the contrary, the recipe is to create rituals and teach by feelings.
A formula that seems to be more effective in dealing with endowment effects than the cold calculating reason of the traditional approach, which otherwise will give you an obvious answer: if it is within your preferences that your house is messy, tidy it up; conditional on your time constraints to do so. Otherwise, chances are you've already found your own disorder optimum.
2- Losses are felt more than gains
A concept strongly related to the previous one is the idea of loss aversion. It is one of the fundamental, and also foundational, concepts of behavioral economics, which shows that there is an asymmetry between the way we value losses in relation to gains. For example, to compensate for the loss of $100 you need to gain $200. In other words, the utility of gaining $100 is much less than the disutility of losing $100.
The concept is fundamental for several aspects. The first is subtle. If what is at stake is profit or loss, what is implicitly being stated is that people react to changes (in the flow of money) rather than to absolute levels (of wealth). Let's think about a multimillionaire soccer player, how can he be? Lionel Messi.
A poor mortal like you or me might wonder what motivates a person with a fat checkbook to continue working. After all, he has wealth large enough to never have to work again, covering high living costs.
If there is a net worth of approximately €230 million, under the traditional economic analysis model an additional €100 thousand would not seem to provide greater utility. However, Messi continues playing because - again - what is taken into account is profit and not accumulated wealth.
The other reason is more explicit, if the agents are adverse to losses, and is complemented by the endowment effect, we are faced with the presence of status quo biases. If any change that does not offer a strong compensation is perceived as a loss, then agents end up being reluctant to change.
The given is taken as a point of reference, creating an impulse to be conservative. Something that our popular wisdom has immortalized with the saying “better evil known than good unknown”, and that even acts against our own interests.
3- I don't know what I want, but I feel like I want it now
It is an oft-repeated phrase that economics is the science of scarcity. Let's see it in this example: at the moment, given that the environmental problem tends to be underestimated, a diamond is worth more than a thousand liters of water. Naturally, water is essential for human survival, while a diamond is not.
However, the fact that the value of the diamond is so high lies in its relative scarcity. And as we said in the first point, in a market economy the valuation of a good is mediated by the price system: if something is expensive, it is because it is worth more.
An astute reader may rebuke us that many times the price is set by a few companies, which does not necessarily reflect their relative scarcity, but rather their market power.
In the previous article we also commented on the difficulties that this central concept presents for the economy. But for the purposes of this note, we are going to focus on highlighting that both the idea of scarcity, as well as the problems of application through the price system, were objective character.
Behavioral economists do not dismiss this concept, nor its difficulties; but they also take into account the effects of subjective scarcity in people's decisions. What is meant by this? Having less than what is perceived as necessary.
The finding of these studies is to postulate that there is a common logic of scarcity that works by capturing the attention of those who feel it (or suffer from it), when they excessively focus their thoughts on it. An interesting aspect of this concept is that the idea applies to all people regardless of their wealth.
Let's think about a doctor with a high income, but little time for his personal life. The experience of scarcity will not be about resources, but about time to - let's assume - dedicate to your family. Now, what implications does the capture? A complete alteration of experience and a reduction in decision-making capacity. Those who feel that they have no time for anything, focus their thoughts on the time that escapes them. What are the effects? Loss of insight, cancellation of innovative thoughts and loss of self-control.
In this way, attention capture works by focusing attention, but in a way so focused on a lack that a cost is paid by losing global calculation capacity. The example we gave of a person with little time was a kind one. Let's think now what happens with a person in poverty situation.
If the scarcity of resources captures your attention, the ability to have innovative thoughts and the ability to create solutions to get out of (or alleviate) that painful situation is nullified. The loss of self-control does not allow for the small savings necessary - for example - to replace a broken tool part with a new one: a sewing machine or a bread oven; with which the vicious circle of poverty is reinforced.
If subjective scarcity has a common structure that determines a person's field of decisions, blaming a poor person for their situation is a brutal conceptual error.
4- What is desirable in the short term may be bad for the future (and vice versa)
In the previous article we mentioned that a good economist must consider how income is distributed. effects over time of an action or measure. For example, and in a very simplified scheme, a sudden monetary issue that is not initially discounted by the market, can lead to a brief period of prosperity in the short term that, if it does not generate a stimulus for a genuine increase in production, leads to an inflationary peak in the medium term.
Thus, what is considered good in the present, can have negative effects in time. However, as the reader will notice, all the expected effects are derived from a rational calculation.
Applying this scheme to the time calculations made by agents, traditional economic thinking affirms that they have preferences for the immediate: $100 now is better valued than those same $100 a year from now. This premise is not minor, since it explains several behaviors.
An example is the behavior associated with collecting prizes. In the US, the prize of winning the lottery can be awarded in two ways: a single payment, or divided into 30 annual installments. The collection system exploits the premise of immediate preference, because when the winner opts for the single payment system, the amount collected is comparatively less than the total that would be collected with the sum of the 30 annuities, with the respective corresponding adjustments in time.
Now, do economic agents think and act under these calculation parameters? Behavioral studies answer this question with a resounding no, due to the existence of problems of self-control that go one step beyond the premise of preference for the immediate. Behavioral economics affirms (and justifies) that economic agents are inconsistent over time when it comes to decision making.
Simpler: even though they have created a plan, and obtain some type of benefit from its observance and monitoring, it is difficult for them to be consistent with it. Let's think about paying the club or gym fee. It is paid, it is recognized that being active is good for health, it is attended for the first few months, and finally it is stopped. Obviously not everyone takes this attitude, but the lazy side of society does.
Even more serious is what happens when self-control problems are combined with capture due to scarcity. Think about what happens with the follow-up of prolonged medical treatment, when attention is captured by another issue. Under self-control and capture, treatments can be partially interrupted, or become poorly administered.
This new understanding of human behavior is more comprehensive, and poses challenges to the public policy design. It's no longer just about improving access problems (to rights, to services, to goods, to medicines) but also to contemplate usage problems (effective exercise of rights, use of services under a certain quality parameter, goods that fulfill the function for which they were designed, medications that are well administered).
5- Many discussions are resolved by measuring, but when it cannot be measured, experiments can be done.
The statistics and econometrics are the dominant tools of applied economics. It makes sense that this is the case, because this instrument allows us to understand the behavior of variables, not only at a descriptive level (the dollar rose, the dollar fell) but also because they allow us to quantify the relationships established between different variables within an economic model (if the issuance of pesos increases, and everything else remains constant, the dollar increases).
But it also makes sense for a contextual issue. He technological change that has been recorded in recent decades, created an exceptional volume of information for this type of studies, which no longer necessarily depend on statistical agencies or on obtaining funds to carry out their own surveys.
Currently, the large volume of information generated is done privately, and many platforms offer free access to their databases for analysis. Such is the case of Twitter, which allows access to its database through its API interface.
Now, what happens when the relevant data of an economic proposition are not directly observable in a natural economic environment? That is, what happens when the theory exists, but not the empirical counterpart that can be measured and then verified.
In this case, two things can be done. Use the deductions from the economic model as true… or put together a experiment. In our lands, this point still appears as a novelty. Until not very recently, a well-known Introduction to Economics text ran like this: “Economists [unfortunately]… cannot carry out the controlled experiments of chemists or biologists… Like astronomers or meteorologists, they must generally content themselves largely with measured by observing.”
Fortunately, the induced value methodology created by Vernon Smith, which earned him the Nobel Prize in Economics 2002, “for having established laboratory experiments as a tool in empirical economic analysis, especially in the study of alternative market mechanisms”; has allowed a series of developments that have facilitated the search for empirical regularities, the dialogue between different theories and the formulation of economic policy recommendations.
Fortunately, the methodology of experimental design has greatly facilitated the validation and emergence of concepts and foundations from the branch of behavioral economics. Perhaps one of the most popular experiments are the ultimatum games, which has application to the field of justice perception, an aspect rarely covered by neoclassical economics.
What is an ultimatum game? Two players are needed. The first player is asked to distribute a certain amount of money – let's say $100 – with the other player through a single and definitive proposal of how to distribute that money. For his part, the second player can accept or reject the first player's proposal. If rejected, neither player gets anything. If accepted, the amount is distributed on the terms of the first player.
In this situation, the prediction offered by the rationalist theory consists of an offer of $99 by the first player and the acceptance of the remaining peso by the second.
At the end of the day, $1 is better than nothing, and both players know it. The strategic calculation would then be something like this: if I know that the other person knows that $1 is better than nothing, then I can keep $99 and offer him $1, because I am certain that he will accept, given that we are both rational.
However, this is not what happens in laboratory experiments. Ultimatum games have shown that people are willing to penalize low-value offers even at the risk of being left with nothing. For their part, those who play the role of bidders assume that this is the case, which is why they end up offering divisions of the money with proportions of the 60% – 40% style.
6- Incentives matter, and sometimes big impacts can be achieved with a little push
In the previous article we argued that incentives - in general - and monetary incentives - in particular - are an essential tool in the formulation and execution of economic initiatives, whether public or private.
An example of the first type could be Universal Child Allowance (AUH) that offers a monetary allowance for the number of children focused on families from vulnerable populations who, in return, must complete the vaccination record and attend classes during the year.
For its part, an example from the private sector are compensation systems in which as one ascends in the hierarchy, additional amenities: corporate car, improvements in the social work coverage plan, home office, transfer possibilities, company actions, etc.
In general terms, what I know is affirmed in both examples, is that people respond to monetary incentives in a predictable sense, based (again) on a notion of calculation. From a behavioral point of view, and having already seen the concepts in the previous points, this is not necessarily the case.
Self-control problems, endowment effects, status quo biases, loss aversion, and scarcity capture; They are all variants of the more global concept of limited rationality. If under certain circumstances, our calculation capacity is compromised, then the decision we make as an economic agent is hardly close to optimal.
What can be done in the formulation of public policies under this scenario? Anticipate the error, and design them considering the decision architecture of those who will be beneficiaries.
What does this mean? That the organization of the context will be taken into account, to propose options that induce the best response under an improvement objective. It sounds strange, but it's actually something we're used to.
For example, a programmer assumes that the user has practically no computer knowledge. For this reason, when a program is installed on the computer, it offers a default configuration or the possibility of modifying these parameters to suit the user (and which is generally not done). The same goes for cell phones. The options are there, but a pre-configured one is offered that is considered desirable.
It is that the default options They have enormous weight, and are closely linked to the status quo effect, discussed above. Under bounded rationality, most decisions are not made based on a calculation, but rather following the option presented. That is to say, continuing the inertia; like someone crossing the street looking at what the person in front is doing, instead of looking at the traffic light.
Now, the fact that a decision can be induced (and this is something that advertising does with us permanently) raises serious concerns. ethical issues in the formulation of public policies. A patient can be induced to take her medication by sending text messages as a reminder. But is this interference ethical? The justification lies in two points.
- The induced option is not the only one available and the decision-making capacity is not nullified.
- The understanding that in practically any circumstance there is no default option that is not neutral. If text messages were not sent when taking medications, knowing that there was a risk of interrupting treatment, would it be ethical?
Finally, when a public policy contemplates the decision architecture of the beneficiaries, it is said that it is providing a Nudge, a small nudge that changes people's behavior in predictable ways without prohibiting any options.
La Justin Law, which comes into force as of August 3, 2018, may be the Nudge largest scale that has been implemented in Argentina. It modifies the default option of organ donation, by reversing the terms. Now everyone over 18 years of age is an organ donor, unless they voluntarily express themselves otherwise. So much so that, according to INCUCAI, the first two months saw an increase of 35% in interannual terms.