Why behavioral economics is critical to revolutionizing economic

Why behavioral economics is critical to revolutionizing economic theory and why it is not enough • The behavioral foundations of neoclassical welfare economics • The behavioral revolution • Neuroeconomics • Behavioral economics and public policy – the obesity epidemic, addiction, sustainability • Institutions and the role of government

Utility theory and its behavioral assumptions • The standard (rational actor) model is constrained by the mathematics of general equilibrium theory. • “Utility” or well-being, is confined to the satisfaction derived from consuming market goods and services: • U = f(Apples, Oranges, etc. ) • A necessary key assumption to make the mathematics work (constrained optimization) is that preferences are self-regarding. • People consistently and rationally allocate their limited incomes so as to maximize their own wellbeing.

Pareto efficiency depends on selfregarding behavior • The proof the efficiency of perfect competition hinges on the assumption that one person’s utility is independent of the utility of others. (also on the firm side – one firm’s output decisions are independent of other firms. • A B • Need that assumption to get the result MRSX for Y = MRSX for Y • One major ideological purpose of the neoclassical model of the economy is to prove that competitive markets are the most efficient way to allocate society’s scarce resources. • Does not work if UA = f(X, Y, Z, …, UB)

Vilfredo Pareto 1897 • “It is an empirical fact that the natural sciences have progressed only when they have taken secondary principles as their point of departure, instead of trying to discover the essence of things…Pure political economy has therefore a great interest in relying as little as possible on the domain of psychology. ” • This attitude led economists to focus on revealed preference, not how decisions are actually made.

Revealed preference Begin with basket of market goods chosen with a given budget constraint and given relative prices. Then you assume that the underlying thought process conforms to “rational economic man”. Transitivity, more is preferred to less, self-regarding preferences etc.

Hal Varian �“A utility function is often a very convenient way to describe preferences, but it should not be given any psychological interpretation. ” �He then goes on to characterize the utility function as exhibiting monotonicity, local non-satiation, convexity and so on. These are psychological assumptions about human behavior. �Mathematical assumptions in economics imply things about the real world. Just like assuming “homogeneity of degree one” implies constant returns to scale in production.

The Ultimatum Game • The Ultimatum Game – really had a huge impact on the field of economics. Werner Güth, Journal of Economic Behavior and Organization 1982 • Suppose someone gives you $100 and asks you to share it with some unknown person. • You can give as much or as little as you like, BUT the person you give the share to can reject the offer. In that case neither of you get anything.

Ultimatum Game results �“Economic men” would offer the minimum and take any positive offer. “More is preferred to less. ” �In cultures with “Western” market economies typical offer is around 40%, anything less than 30% is usually rejected. �These results have been consistently found in hundreds of studies in a variety of settings and cultures.

Cross-cultural Ultimatum Games • Joseph Henrich et al. American Economic Review 2004 • An extensive study involving economists and anthropologists played the ultimatum game in 15 different cultures • “The canonical model of self-interested behavior is not supported in any society studied. ”

Kevin Mc. Cabe - Ultimatum game • • ● ● ● • Subjects who had a diagram like this near them made higher UG game offers.

Neuroeconomics �Neuroscience has validated and deepened our understanding of the regularities discovered by behavioral economics. �It has helped identify what’s missing from standard economics. For example, the role of automatic and emotional processing in decision making. �Shows the biological evolution of the “sociality” of humans

Ernst Fehr – Oxytocin an the Ultimatum game • Subjects who were given oxytocin made higher offers (80%higher) than those who were given a placebo. • Oxytocin did not effect the rejection rates. • This indicates that emotions drive generosity. • Oxytocin and social bonding: mother-child, pairs of animals.

Von economo neurons • Also called spindle neurons. • Purpose is allow rapid communication between the visual cortex and the parts of the brain associated with judgment and self esteem. • Found in highly intelligent social animals, great apes, cetaceans, elephants. • Case of “Michael” the gorilla (Allman)

Colin Camerer �Economists: preferences behavior �Neuroscience: explicit behavior is only one of many mechanisms that the brain uses to maintain homeostasis. �“Rather than viewing pleasure as the goal of human behavior, a more realistic account would view pleasure as a homeostatic cue – an informational signal. ” �Are you content that things are in balance, or are you unhappy that things are not in balance? Plays a huge role in decision making.

Behavioral economics and policy • Blood donations – offering money actually reduces blood donations. • “Opt in” versus “opt out” in the case of organ donations • Design of pension plans – start low, increase contributions proportionately more as income goes up.

The limitations of behavioral economics • Obesity • “Richard Thaler’s work is important for understanding obesity precisely because he brought the discipline of an economist to understanding why people make seemingly irrational choices. • In the popular imagination, obesity is a failure of self-control. But Thaler’s work offers a sharp contrast. Self-control is, in fact, unusual. That’s because most people make daily lifestyle choices based on what is easiest and most immediately pleasing. This is nothing new. • What’s new is the abundance of options that are so easy, so pleasing, and in the long run, so harmful to our physical health. “Have a Coke and a smile! Makes you feel gooood. ” “You want fries with that? ”

But why is the obesity epidemic so recent?

The limitations of behavioral economics • Addiction • Economists focus on addiction as an individual behavioral problem. • But why the difference in the last 15 -20 years? • The death rate from drug overdoses jumped from an average of 6 per 100, 000 in 1999 to 16 per 100, 000 in 2015. • 2016 – 64, 000 deaths • 2015 – 52, 000 deaths • 2000 - 18, 000 deaths

Addiction Solution? More money for the drug industry • The pharmaceutical industry was listed as one of the “Contributors to the Current Crisis” in the final report of President Trump’s Commission on Combating Drug Addiction and the Opioid Crisis. The report cites decades of aggressive marketing and industrysponsored physician “conferences” aimed at expanding opioid use by minimizing the dangers of addiction. Lawsuits by state attorneys general, counties and local jurisdictions allege that the industry fostered the epidemic by overpromoting its products, while raking in billions as Americans became addicted and overdosed. “To this day, ” the commission says, “the opioid pharmaceutical industry influences the nation’s response to the crisis. ” • It sure does. In its response to an epidemic that now kills 50, 000 Americans a year, the Trump administration wants to spend tens of millions of dollars in part to help the industry responsible sell ostensibly nonaddictive pain medications and “abuse deterrent” opioids that are as addictive as the original opioids.

The limitations of behavioral economics • Sustainability • “Unsustainable behavior” is blamed on individuals, or human nature. • William Rees, Reg Morrison • The real problem is the economic system we have accidently evolved into. Surplus production generates a superstructure of support—political, religious, ideological. All of us are locked into this system.

The role of government • The old individualistic economic models perpetuate the myth of the dichotomy between "the government" and the "free market. " • Society, economy, and government is one unified system. In every developed economy government spending accounts for between 40 -50% of GDP. It's just a matter of who gets the money and which sections of the economy are supported and which are not. • Who does the government work for? Who does it give its money to? U. S. health care as an example.

Marriana Mazzucato • https: //www. youtube. com/watch? v=p 4 Dhbj. Z 74 IQ • “The real innovation engine in the global economy is not the entrepreneurial class blazing capitalist trails through the thicket of government red tape and taxation. No. The real engine of innovation is government. ” Economist Mariana Mazzucato’s “case study for myth-debunking is the i. Phone, that icon of American corporate innovation. Each of its core technologies–capacitive sensors, solid-state memory, the click wheel, GPS, internet, cellular communications, Siri, microchips, touchscreen—came from research efforts and funding support of the U. S. government and military. Did the public see an i. Phone dividend? Not really. ”

Regularities in economic history • Economists are beginning to return to the roots of our profession and rediscover “political economy. ” • What are the institutional and biophysical drivers of economic evolution? • The Son Also Rises – Gregory Clark • Capital in the 21 st Century – Thomas Piketty • The Great Leveler – Walter Scheidel

Thomas Piketty – The economic evolution of capital and labor • There is a natural tendency for money (capital) to flow to the top income groups. • Q = f(K, L) • r. K/w. L = relative incomes of owners and • workers • r. K/Q capital’s share of economic output w = wage rate r = rate of return on investment g = growth rate of GDP Capital’s share of GDP increases in r > g

The Great Leveler – Walter Scheidel • “Ever since humans began to farm, herd livestock, and pass on their assets to future generations, economic inequality has been a defining feature of civilization. Over thousands of years, only violent events have significantly reduced inequality. The “Four Horsemen” of leveling – massmobilization warfare, transformative revolutions, state collapse, and catastrophic plagues – have repeatedly destroyed the fortunes of the rich. ” • This has been the pattern for 10, 000 years.

Behavior and Governance at Three Levels • Individual – Most of the focus of behavioral research and policy has been on the behavior of individuals. • Social – Some research has been done on how individuals function as members of social groups. A little research has been done on groups as decision-makers. • The global economy – Relatively little work has been done on the behavior of “societies” and global governance.