April 28, 2015

Behavioral economists discuss their emerging field

Real humans do not behave like simplified models of standard economics, said economist Richard Thaler. Standard economics models imply, for example, that the best possible gift is cash, “but would you give cash for Valentine’s Day?” he challenged a packed auditorium April 26 at the “Behavioral Economics Revolution” panel Charter Day Weekend. “If humans were all like [Star Trek’s] Spock, economic theory would be accurate, but we’re more like [the cartoon character] Homer Simpson.”

Unlike standard economics, behavioral economics takes into account such things as how questions are framed as well as the initial allocation of resources. “Everything in behavioral economics is perfectly obvious to psychologists and anyone with sense,” noted Thaler, of the University of Chicago.

But there was – and continues to be – tremendous resistance among economists to the findings of behavioral economics. “Academics are skeptics,” said Ted O’Donoghue, the Zubrow Professor of Economics in the College of Arts and Sciences. And, he noted, the goal of the standard economic model is not to develop the best model of the individual, but to have a simplified and reasonable model of the individual with which to study market outcomes.

However, said, O’Donoghue, simplifications of the standard model result in misleading conclusions. The deviations of real people are not just noise; systematic behavioral forces are quite coherent. The good news, he said, is that the behavioral agenda is starting to win over the majority of economists and to be applied to policy analysis. “Behavioral economics has helped us understand the world, now we can use it to improve the world.”

Machine intelligence, too, has a great deal to teach us about human thinking, according to Sendhil Mullainathan ’93 of Harvard University, highlighting human failures but also the ways in which humans are exceptional. Algorithms are much more accurate than humans at prediction when sample sizes are very big, for instance, but when working with small samples of data – or with new things – you can see the power of human intelligence. “The next wave will be a movement away from understanding human failures to how we do all these things in such an amazing and intuitive way,” he said.

Much of psychology professor Tom Gilovich’s work in behavioral economics has focused on the study of human happiness. His experiments have identified three simple ways to enhance happiness, he told the audience. The first way is to invest in experiences over possessions. Experiences connect us to other people, he explained, and form a bigger part of our identity. They’re also less likely to prompt deflating comparisons with other people.

The second method is to be active. “We evolved to be goal-striving creatures,” he said. “You’ll regret more the things that you didn’t do rather than the things you did.” Finally, he urged the audience to “mind your peaks and ends. You won’t remember the length of your vacation experience, but you’ll remember the intensity. And do something special at the end.”

Spending on that vacation, though, is not easy for many these days. Robert Frank, the Henrietta Johnson Louis Professor of Management and professor of economics, noted the problem of rising income inequality. Rather than framing the issue as a discussion of justice and fairness, Frank said inequality is a bad thing, in purely practical terms, for rich people as well.

With all significant income increases going to people at the top of the income distribution, there’s been an “expenditure cascade,” said Frank. “People just below the top income level emulate the top, and so on down the income ladder. The result is that median new houses are now 50 percent bigger than their counterparts in 1980. People in the middle must spend now more because the people above them are spending more. Failure to follow suit would consign their children to below-average schools.”

Linda B. Glaser is a writer for the College of Arts and Sciences.