Behavioral Economics

Why do so many Americans receive such a big tax refund? Every year, the IRS sends a check of around $3,000 to Americans who paid more taxes than they should. The excess withholding is a puzzle: why do consumers prefer to give the U.S. government an interest-free loan? Wouldn't a quick trip to the payroll administrator be worth the effort if it meant a bigger paycheck? Michael Barr, an editor of the RSF volume Insufficient Funds, spoke to the Wall Street Journal last week about his research on the problem:

"People want to have a ready way to save," says Michael Barr, a University of Michigan law professor and a former Obama and Clinton Treasury official. "For some families, tax time is a good time to do so."

In the mid-2000s, Mr. Barr and colleagues surveyed about 650 low- and moderate-income families in the Detroit area who had filed tax returns in 2003 or 2004. About 82% received refunds—either because they had overpaid or because they qualified for the federal Earned Income Credit, a federal cash bonus to low-wage workers that is paid through the IRS. [...]

In fact, Mr. Barr and co-author Jane Dokko of the Federal Reserve Board, found these folks don't want smaller tax refunds. In the survey, researchers offered them choices: Withhold $100 a month more and get a bigger refund (an option favored by 35%), withhold the same amount and get the same refund (46%) or withhold less and get a smaller refund (only 19%.) This and other survey findings appear in a coming Brookings Institution book, "No Slack: The Financial Lives of Low-Income Americans."

The Wall Street Journal profiled economist Yale psychologist Laurie Santos and her work on the origins of human irrationality. Santos, who co-published a study funded by the Russell Sage Foundation, conducts experiments with Capuchin monkeys in her lab to observe if systemic decision-making errors like loss aversion extend beyond the human species. Her research has produced some surprising results:

In one experiment, they gave each monkey a wallet filled with 12 flat aluminum tokens, monkey money that the animals could trade for food. Right away, the scientists saw the similarities to human behavior. When researchers slashed the price on certain foods, the monkeys sought out the best deal. They also typically spent all their cash at once and didn't bother to save.

Then researchers decided to test a more complex economic theory which shows that people do not judge price in a vacuum. Sitting with the team at the coffee shop, Dr. Santos could see how the concept worked in her own life. Many days, she feels guilty about spending $2.20 on a cup of coffee. But when she looks up at the chalk board listing drink prices, the Nutella Latte goes for $3.85 and the Ginger Snap is $4.15. "My $2 cup doesn't seem as expensive anymore," she said.

Monkeys make similar assessments. In one experiment, a researcher showed a monkey two pieces of apple but handed over one in exchange for a token. A second researcher showed one piece of apple and gave the slice to the monkey for the token. The monkeys strongly preferred to trade with the second researcher. They did not like being offered two apple pieces and then only getting one.

For more information on this line of inquiry, see Santos' RSF-funded study: "How Basic Are Behavioral Biases? Evidence from Capuchin Monkey Trading Behavior." Here is the abstract:

As we discussed in this post, the Russell Sage Foundation played an instrumental role in the development of behavioral economics. Readers looking for a quick introduction to the discipline can find a series of articles below from the field's leading scholars. As with our reading list on inequality and mobility, this list is not meant to be exhaustive; users looking for more advanced research should see these reading lists, as well as the Foundation's behavioral economics program page, which lists our current research initiatives.

GENERAL INTRODUCTION

"A Short Course in Behavioral Economics." The Edge.org. October 1 2008. Web. March 23 2012.

Camerer, Colin. 1999. "Behavioral economics: Reunifying psychology and economics." Proceedings of the National Academy of Sciences 96 (19): 10575-10577.

Kahneman, Daniel. 2003. "Maps of Bounded Rationality: Psychology for Behavioral Economics." American Economic Review 93 (5): 1449-1475. (PDF)

Laibson, David and Richard Zeckhauser. 1998. "Amos Tversky and the Ascent of Behavioral Economics." Journal of Risk and Uncertainty 16 (7): 7-47. (PDF)

Lambert, Craig. 2006. "The Marketplace of Perceptions." Harvard Magazine. Online. March 23, 2012.

Mullainathan, Sendhil and Richard Thaler. 2000. "Behavioral Economics." MIT Working Paper 00-27.

Rabin, Matthew. 1998. "Psychology and Economics." Journal of Economic Literature 36 (1): 11-46. (PDF)

Rabin, Matthew. 2002. "A Perspective on Psychology and Economics." U.C. Berkeley Working Paper E02-313.

Thaler, Richard and Cass Sunstein. Nudge: Improving Decisions about Health, Wealth and Happiness. New Haven: Yale University Press, 2008.

Late last year, we posted TED Talk videos from Daniel Kahneman, Sendhil Mullainathan and Dan Ariely, three scholars involved with RSF efforts to study consumer finance. The talks offer an excellent introduction to the methods and insights of behavioral economics, which the Foundation has supported since the early 1980s.

This month, economist Shlomo Benartzi gave his own TED lecture in New York on how to improve money management among consumers. Benartzi, a member of RSF's Behavioral Economics and Consumer Finance Working Group, discusses research from the field of behavioral finance, which he says is a "combination of psychology and economics trying to understand the money mistakes people make." Watch the video below:

Last year, we discussed a study that examined a new way to encourage people to save for retirement. The study, partially funded by the Russell Sage Foundation, attempted to align savers' present-day interests with those of their future, older selves by showing them, among other things, digitally aged photos of themselves. One of the study's authors, psychologist Daniel Goldstein, talks more about the evidence and theory behind the experiment in the TED Talk below. Read the full text of the study for more.

In a famous 2011 study, Michael I. Norton and Dan Ariely conducted a survey that asked a sample of Americans to build their ideal distribution of wealth. They also asked respondents to estimate how much wealth each quintile in America actually had. The results, depicted in the graph below (Adobe Flash required), were surprising:

The Economist talked to Nobel Prize-winning psychologist Daniel Kahneman about his new book Thinking, Fast and Slow and his research on decision-making, well-being and behavioral economics. During the course of the interview, Kahneman, a member of RSF's Behavioral Economics Roundtable, offers suggestions for more reading and cites Nudge, a popular book about behavioral economics co-authored by RSF trustee Richard Thaler. Here is a sample of the interview:

More on RSF's Summer Institute
• Application Announcement
• Agendas for Previous Conferences
• E-mail for More Information

Applications are now being accepted for Russell Sage Foundation's tenth Summer Institute in Behavioral Economics, a two-week workshop that offers a competitively selected group of young scholars a concise introduction to recent trends in behavioral research. Co-organized by David Laibson and Matthew Rabin, this year's workshop will be held in Waterville Valley, New Hampshire, from July 1 to July 13, 2012. Topics to be discussed will include decision-making under risk and uncertainty, intertemporal choice, biases in judgment, mental accounting, and social preferences, as well as the implications of these foundations for savings behavior, labor markets, development economics, finance, public policy, and other topics in economics. Visiting faculty will include Colin Camerer, Stefano DellaVigna, George Loewenstein, Ulrike Malmendier, Sendhil Mullainathan and Richard Thaler.

For more information on eligibility and application requirements, click here. Below are some FAQs; additional inquiries can be sent to RSF.Summer.School@gmail.com.

In his latest column in the New Yorker, financial writer James Surowiecki reports the return of a retail phenomenon not seen since the Great Depression: the layaway purchase. Before the financial crash, the default payment mode for consumers was the credit card. Buy now, pay later. Now, as the financial crunch continues to pinch pockets, more stores are offering layaways. Here's how they work:

You pick out the product you want, make a down payment, pay a service fee (typically five dollars), and then make regularly scheduled payments over a period of time until you’ve paid off the full price. There are no interest payments, and if you don’t make all the payments you get your money back, minus a cancellation fee. It’s the exact opposite of installment credit, where you get the product, and then pay for it.

According to standard economic theories, Surowiecki explains, rational consumers would not choose the layaway. Why not simply save enough money in a bank account and then head to the store? Or why not use your credit card and pay the balance in a sustainable manner? But Surowiecki cites RSF-funded research in the field of behavioral economics to explain the appeal of layaways:

Here are four videos featuring RSF-affiliated scholars from TED.com, an excellent nonprofit dedicated to discussing and spreading new ideas. The scholars below are Daniel Kahneman (a member of RSF's Behavioral Economics Roundtable); Sendhil Mullainathan (a grantee and member of RSF's Consumer Finance working group), Dan Ariely (who contributed to the recent consumer finance issue from the Journal of Marketing Research), and Shlomo Benartzi (also a member of RSF's Consumer Finance working group).

1. Daniel Kahneman discusses his research on happiness and memory. You can read more about this line of research in his RSF volume, Well-Being: The Foundations of Hedonic Psychology.