Issue: Behavioral Economics Behavioral Economics

Home , Hersh Shefrin, Nava Ashraf, Sendhil Mullainathan, StickK

Issue: Behavioral Economics

Behavioral Economics

By: Victoria Finkle

Pub. Date: May 9, 2016 Access Date: October 1, 2021 DOI: 10.1177/237455680210.n1 Source URL: http://businessresearcher.sagepub.com/sbr-1775-99729-2729522/20160509/behavioral-economics ©2021 SAGE Publishing, Inc. All Rights Reserved. ©2021 SAGE Publishing, Inc. All Rights Reserved.

Will a better understanding of behavior improve economic models? Executive Summary

No longer a fledgling challenge to traditional theories, behavioral economics is a growing field of study incorporating how human psychology affects economic decisions. Economists have long held that humans are perfectly rational actors who know how to maximize their own happiness. Supporters of behavioral economics say this is simplistic, and that humans are anything but rational. They argue that a greater understanding of human motivations and incentives can improve economic models and spur better policy in government and business. Behavioral economics, they say, can influence everything from what people eat for lunch to how much they save for retirement to how companies engage with their customers. But critics respond that behaviorial economics has limitations and that efforts to influence behavior, sometimes known as nudges, aren’t as powerful as the field’s cheerleaders hope. Among the questions under debate: Will behavioral economics replace traditional economics? Should business or government “nudge” people toward certain behaviors? Can behavioral economics make managers and firms more effective? Overview

HSBC gives London train travelers a “nudge” to keep their New Year’s resolutions. Behavioral economics provides the basis for interventions, known as nudges, to improve endeavors such as corporate marketing. (Stuart C. Wilson/Getty Images for HSBC)

When Bruce Palmer decided he wanted to lose weight, he made sure he had some skin in the game. He had recently heard about stickK, a company developed by Yale University behavioral economists Dean Karlan and Ian Ayers in 2008, which helps people stick to their goals. 1 Participants put up money as an incentive to stay on track, with the proceeds going to either a friend (or frenemy), a charity—or an “anti-charity” if they fail. Palmer lost 40 pounds in 2013 using stickK, and when surgery and some health complications forced him to stop his workouts temporarily, he returned to the company again in January 2016 to battle some of the weight that had returned. He chose the anti-charity option both times, knowing that if he didn’t make his weekly weight-loss targets, he’d be donating to groups he strongly disagrees with, including Americans United for Life, an anti-abortion group, and the National Rifle Association. “I think that’s the extra motivation—there’s no way I’m giving those people money,” says Palmer, 54, who owns an IT consulting business in New York City. Palmer was also careful to put enough money on the line that he would think twice before slacking off. He wagered $50 per week in 2013 that he would make his weekly weight-loss goal over the course of several months, and upped the stakes to $100 a week in 2016. “If it were $5, who cares?” he says. “I’ll have an extra piece of pie for $5. But I’m not going to have the extra piece for $100, so it’s a different situation.” StickK’s model makes use of a powerful concept in behavioral economics called the commitment device, which creates an incentive for people to stay on track with self- prescribed goals. Nobody likes losing money, especially to a charity that clashes with one’s personal or political beliefs. What behavioral economics does is to apply such psychological insights to human behavior to better inform how and why people make economic decisions. “Our consumer site is based on a fundamental finding in behavioral economics, which is that the stick is more powerful than the carrot,” says Jordan Goldberg, the company’s CEO, who says that people seek out the website for all kinds of efforts. He’s seen everything from the expected, such as losing weight or keeping up with homework, to the downright quirky, such as learning how to use chopsticks. And the available evidence seems to support the company’s approach. People are nearly twice as likely to succeed if they put money on the line—the success rate almost doubles from 46 percent to 85 percent—and they’re somewhat more likely to follow through when they use the anti-charity option, according to data provided by stickK. Nearly 89 percent of those who select an anti-charity keep their goals, while 81 percent of those who pick the charity option follow through on their objectives. For the anti-charity option, stickK allows users to choose between opposing groups on either side of contentious issues like abortion, gun control and gay marriage. With the charity option, the money goes to a cause chosen at random from a predefined list for those who fail, including places like the American Red Cross and Doctors Without Borders. “We don’t let people choose an individual charity, because we don’t want it to be too much of a silver lining for not succeeding,” says Goldberg. “We don’t want people saying, ‘Oh well, at least my money is going to a cause I really care about, therefore it’s not a big deal that I didn’t succeed at my goals.’ We’re happy that we’re raising money for charity, but at the end of the day, our mission, our reason for being, is to help people improve themselves and accomplish their goals.”

Among those who opt to hand over their money to an individual—a “friend or foe”—79 percent succeed. The popularity of the company’s approach—users have created more than 307,000 commitments and put more than $25 million on the line since 2008—underscores how far behavioral economics has come. 2 The field has grown rapidly over the past several decades to become a powerful, even disruptive force. Higher Stakes Boost stickK Users’ Success Rates

Success rate for stickK users, by type of stake

Notes: Data represent commitment contracts from 2011 through June 2014. "Success rate" shows the number of reports of success submitted by users divided by the total number of commitment contracts. “Friend or foe” means an individual who receives money from the user if he or she fails to meet his or her goals. Source: stickK

The Web startup stickK helps users meet their goals by requiring them to sign commitment contracts with optional monetary stakes. From the beginning of 2011 through June 2014, 85 percent of users with money at stake met their goals, while less than half of those with no stakes did. Those who signed “anti-charity” commitments, which require them to donate money to groups with whom they disagree if they fail, were more likely to meet goals (89 percent) than those who agreed to give money to favorable charities (81 percent) or individuals (79 percent) —“friends or foes”—if they failed.

Percentage of stickK user commitments, by type of stake

Its aim is to improve the precision of some key assumptions about how people make decisions. Traditional economists build theories on the notion that humans are perfectly rational actors who know how to maximize their own happiness; behavioral economists consider how emotions and psychological programming can undermine such assumptions. These insights have profoundly affected business people, investors, consumers and policymakers alike, although critics warn that the field is not a replacement for traditional theories and can’t solve all economic issues. The study of behavioral economics began to take off in the late 1970s, when an increasing number of psychologists and economists began to question the accuracy of “homo economicus,” the economic man, who is fully rational, self-interested and exhibits complete self-control. 3 “If you look at economics textbooks, you will learn that homo economicus can think like Albert Einstein, store as much memory as IBM’s Big Blue [computer], and exercise the willpower of Mahatma Gandhi. Really. But the folks that we know are not like that,” wrote Richard H. Thaler and Cass Sunstein, two leading behavioral economics researchers, in their 2008 best-seller, “Nudge.” 4 “Real people have trouble with long division if they don’t have a calculator, sometimes forget their spouse’s birthday, and have a hangover on New Year’s Day. They are not homo economicus; they are homo sapiens.” Of course, even the most ardent defenders of economics have conceded that these generalizations were not intended as gospel—they’re used to simplify theoretical models. The study of behavioral economics sheds light on the idea that deviations from total rationality and complete willpower aren’t random; they’re actually measurable, predictable and systematic, at least in some cases. “You have this whole field of economists that are very much into modeling, precision and making inferences from assumptions, who always would have admitted that rationality isn’t a pure description of the world. But how do you model irrationality?” says Ted Gayer, vice president and director of the economic studies program at the Brookings Institution think tank in Washington. “And here you had psychologists not just modeling irrationality, but systematically, in ways that offer predictions on behavior.” For an example of how some of these insights work, consider two examples: 5 1. You are given $1,000, and then presented with two options to win additional money: a guaranteed $500 extra, or a 50 percent chance to win $1,000 more. 2. You are given $2,000, and then asked to choose between these options: a certain loss of $500 of it, or a 50 percent chance of losing $1,000. Considering each case separately, which option would you prefer? The odds, in terms of your final level of wealth, are exactly the same: in both scenarios, you can take a guaranteed payout of $1,500, or can gamble on a 50 percent chance of pocketing $2,000 while running an equal risk of netting only $1,000. Standard economics would say that those totals are what matters and that you should value these two scenarios equally as a result. But behavioral economics takes a deeper look at the process of losing and gaining wealth. When asked to choose, most people select the sure bet in the first example and the gamble in the second. That’s because the thought of losing money is about twice as painful as gaining it is pleasurable. Insights like these have helped rocket behavioral economics into the mainstream when it comes to designing everything from retirement plans to cafeteria lines, and it provides the basis for interventions, sometimes known as nudges, designed to improve endeavors ranging from government policies to corporate marketing to stock trading. Even the White House has adopted a behavioral economics unit, as have governments around the world.

In the corporate world, the British newspaper publisher News UK was able to increase subscription sales by reshaping the way its call center employees spoke with customers, based on techniques derived from behavioral economics, such as playing upon the strong human aversion to missing an opportunity. Polling firm Gallup has found that companies applying behavioral principles—especially in customer engagement—achieved substantial sales and margin growth. “Contrary to popular wisdom, our emotional traits are in fact quite predictable, and it is this long-ignored aspect of employee-customer relations that holds the key to superior performance and long-term growth,” wrote John Fleming, chief scientist of customer engagement and HumanSigma at Gallup and James Harter, the company’s chief scientist of workplace management and well-being. 6 (Gallup defines human sigma as the process of improving and reducing variability in the engagement levels of employees and customers.) The results of some interventions can even affect matters of life and death. For example, whether a person must “opt in” or “opt out” on the decision to donate organs posthumously radically influences donation rates, researchers have found. They say that in countries such as Austria, where there is “presumed consent” that vital organs may be used upon death unless a person explicitly says no, rates of consent can exceed 99 percent. Where citizens must actively sign up as donors, rates are significantly lower; in Germany, participation is closer to 12 percent. In the United States, which also practices “opt in” donation, the rate is about 38 percent, with some states, such as Illinois, practicing 7 a “mandated choice” model, where people are asked to decide whether to be donors at the Department of Motor Vehicles. Cass R. Sunstein: Helped popularize the idea of the As economists, policymakers, business executives and others ponder the implications of behavioral economics for businesses, governments and individuals, here are some of the questions under debate: nudge. (Taylor Hill/Film Magic) Weighing the Issues Will behavioral economics replace traditional economics?

Given the widespread popularity of behavioral economics in the media, many wonder whether the days of the perfectly rational “economic man” construct are over. In an increasing number of cases, researchers are finding that psychological insights can help improve understanding of motivations and decision-making patterns, and potentially improve long-standing economic models and theories. For academics on both sides of the debate, the question is often less about whether behavioral economics will overtake traditional economics and more about whether—or when—the two will merge. “When all economists are equally open-minded and are willing to incorporate important variables in their work, even if the rational model says those variables are supposedly irrelevant, the field of behavioral economics will disappear,” Thaler, a behavioral pioneer, wrote in his 2015 book, “Misbehaving.” 8 “All economics will be as behavioral as it needs to be.” David Levine, a professor of economics at Washington University in St. Louis, who has at times been critical of some of the insights gleaned from behavioral economics, makes a similar point about the blending of approaches, as psychological findings are integrated into existing theories. “Like any other line of research, there’s good pieces that will survive the test of time and there’s bad pieces that won’t,” he says. “But I think it’s doomed as a separate study apart from mainstream economics. The parts that are good will become part of mainstream economics and people won’t view them as some sort of different discipline or separate subject.” Others see behavioral economics as complementary to traditional economics, not an either/or proposition. Many economists now borrow from both traditional models and behavioral insights without having to swear allegiance to one or the other. “If you believe in behavioral economics, you can still believe in supply and demand,” says Todd Knoop, a professor of economics at Cornell College in Mount Vernon, Iowa. “They really help us think about different aspects of different problems. I actually think the more you understand about behavioral economics, the more you appreciate what the rational actor models can tell you and what they can’t.” The two often employ different methodologies for getting at different kinds of information, and both have strengths and weaknesses. While many economists tend to work with large, static datasets, behavioral economists do much of their work in the lab or by running field experiments. This can cause some tension, as critics of behavioral approaches argue that researchers rely too much on university students as subjects and that lab results can be difficult to replicate in the real world. 9 While much has been learned over the past few decades as the field has developed, behavioral economics is still in many ways in its infancy. Opponents say that, so far, the research has been more useful for demonstrating nuances in human behavior—a bunch of “special cases”—than for developing alternative models that fundamentally challenge the current framework. 10 “At this point, it’s a collection of interesting stories and anecdotes, rather than a threat of overturning economics,” says Mark Calabria, director of financial regulation studies at the Cato Institute, a libertarian think tank in Washington. Indeed, while some behavioral findings may provide a better description of human behavior, they don’t necessarily displace the predictive power of standard economic models. Such models are intentionally pared down, because including everything that’s known about behavior would overload any model. “Psychologists are much more focused on individual people,” says Levine. “Part of the problem isn’t that their insights aren’t valuable, the problem is that their models of a single person are suddenly too complicated to be useful for an economist. The purpose of economics is not to understand what happens in a person’s brain or the details of how people interact, but to capture enough of what’s important in order to understand what happens in the market, what happens in the economy.” Stripping away the nuance of individual decisions is important for economists with a focus on microeconomics, or the study of individuals and groups of people, as well as macroeconomics, the study of whole economies and nations. So far, much of the work in behavioral economics has focused on individuals—either alone, as in the gambling problem above, or in groups, as with research on why people fail to save for retirement. There’s been less attention paid to how the field impacts entire economies. Some economists, most notably Thaler, have argued that more work needs to be done to apply these insights to policy decisions at the macroeconomic level as the field continues to evolve. Should business or government "nudge" people toward certain behaviors?

Perhaps the most well-known application of behavioral economics is the idea of the “nudge,” popularized by Thaler and Sunstein and used in a vast number of public policy and private-sector contexts.

“A nudge, as we will use the term, is any aspect of the choice architecture that alters people’s behavior in a predictable way without forbidding any options or significantly changing their economic incentives,” the two researchers wrote. 11 “To count as a mere nudge, the intervention must be easy and cheap to avoid. Nudges are not mandates. Putting the fruit at eye level counts as a nudge. Banning junk food does not.” The theory behind nudging is sometimes called “libertarian paternalism,” as it is “a relatively weak, soft, and nonintrusive type of paternalism because choices are not blocked, fenced off, or significantly burdened,” according to Thaler and Sunstein. 12 The idea is that leaders, or “choice architects,” can design programs and policies— even cafeteria lines—to better serve people in indirect ways. The approach is considered paternalistic because it does more than just track choices; it tries to influence them, ideally for the better. Proponents of this strategy say that so-called choice architecture is inherent in the decisions people make every day, whether they’re paying attention or not. The cafeteria will be organized one way or another—fruit and candy will both be served—so why not do it in a way that will encourage people to make healthy decisions? “I think the big piece of the conversation we forget is that any decision is a decision. If I decide not to decide, you’ve still left the environment random,” says Kristen Berman, co-founder of Irrational Labs, a nonprofit behavioral consulting company she started with Dan Ariely, a prominent behavioral economist. One of the most widely cited cases of nudging focuses on retirement savings. While traditional economic theory would suggest that people simply need to project costs over their lifetimes and calculate how much they’ll need to save to retire, there’s strong evidence that they struggle to make these trade-offs. The average working household has virtually no retirement savings. When all working-age households are included—not just households with retirement accounts—the median retirement account balance is $2,500. For those nearing retirement, the figure is $14,500. 13 When starting a new job, employees are often asked about signing up for retirement savings, typically using a 401(k) account in the private sector. Economists have learned that default options make a big difference with these kinds of programs. If workers are automatically enrolled in a savings program, they are vastly more likely to stay in it. If they must actively choose to sign up, and have to fill out cumbersome paperwork to boot, the odds of that happening are greatly reduced. In 1998, Thaler tested a program with economist Shlomo Benartzi called Save More Tomorrow, which takes the notion of the default to another level: gradually raising the amount contributed to a 401(k) account over time, alongside pay raises. Workers at a midsized manufacturing firm who chose to join the experiment saw their savings rate rise over three and a half years (and four pay raises) from just 3.5 percent of their income to 13.6 percent. 14 But despite the popularity of nudging, especially in public policy, the approach isn’t a cure-all. Some opponents remain concerned about cases where the nudges become more like shoves, and there’s no consensus about where to draw a line. Others have pointed out that clever tweaks to existing systems aren’t sufficient to solve some of society’s biggest problems. 15 One study found that several methods for increasing savings among the poor failed, not because of cognitive biases or a psychological inability to save, but simply due to “liquidity constraints”—otherwise known as a lack of money. 16 Critics also worry that the approach can be harnessed to less scrupulous purposes by those looking to simply line their pockets. “You can think of it as having a light side and a dark side,” says John Beshears, an assistant professor of business administration at Harvard Business School. Richard H. Thaler: A pioneer in He points to the use of rebates on consumer goods, which can serve as a sort of nudge in the opposite direction. While mailing in the rebate behavioral economics. (Jim card can amount to substantial savings, many people neglect to do so, despite already factoring the discount into their decision to buy the Spellman/WireImage) item. “Of course, what companies are banking on is that not everyone is to going fill the rebate out and send it back,” Beshears says. “So some people who thought they were buying the item for 80 percent of the price are actually paying full price.” Alain Samson, a psychologist who consults on behavioral methods and edits an annual Behavioral Economics Guide, says questions remain about whether nudging actually leads to lasting change. For example, recycling at work because the bin is in a convenient place might not transfer to similar practices at home. 17 “If nothing becomes internalized, you may not be successful in the long run,” he says. Can behavioral economics make managers and firms more effective?

As behavioral economics has gone mainstream, companies are increasingly interested in applying practical insights with both employees and customers. One broad finding that should be concerning for employers: Cheating is “infectious,” according to Ariely, the behavioral economist. 18 He has conducted a number of experiments that found that “most of us, when tempted, are willing to be a little dishonest, regardless of the risks.” 19 In one such study, people were inclined to lie about how many math problems they had completed if they believed the answers would not be checked, for even small amounts of money. 20 Ariely also discovered that working in groups exacerbates this effect, as people shade the truth for the sake of the group’s performance. 21 “These findings have serious implications for unsupervised collaborative work in organizations,” he wrote in 2009. “Although work groups can have many social and functional advantages, they may also be more vulnerable to unethical conduct.” 22 On the upside, Ariely has discovered that reminding people about their own moral standards, either by having them recite the Ten Commandments or sign an honor code, seems to eliminate the cheating. 23 Elsewhere, a growing number of firms are trying to use behavioral techniques to improve business practices. For example, Ogilvy Change, the behavioral group housed in global advertising and marketing firm Ogilvy, says it was able to vastly improve subscription sales for News UK by helping call center workers tweak their interactions with customers. The workers now use phrases such as “I wouldn’t want you to miss out” to invoke a sense of loss, playing on the fact that people hate losses more than they enjoy gains. The callers are also trained to reframe negative feedback by remaining positive during the conversation and reminding customers that they can cancel at any time if they’re unhappy with their purchase. The result? Calls that employed the techniques were three times as successful as those that didn’t, and workers were able to save a customer subscription or make a sale 80 percent of the time, according to Ogilvy.

“If you want the world of business to understand the value of behavioral science, one of the first things that you’ve got to get across, which sounds trivial, but it is vitally important, is the understanding that small changes can have very large effects,” adman Rory Sutherland, who co-founded Ogilvy Change, said in 2015. 24 A study by Gallup found that a group of 10 unnamed companies that applied various behavioral economics principles grew sales 85 percent faster than competitors and earned 25 percent more in gross margin in a single year. Gallup’s research centered on better engaging customers and employees by focusing on the role emotions play in decision making. 25 Beshears, who co-chairs a Harvard Business School executive education program on applying behavioral economics to organizational problems, says there is “enormous potential here. Companies are increasingly moving in this direction and trying to harness behavioral insights to make workers more effective and to connect better with customers, but there’s a lot more to be done.” Beshears recently published a case study focused on Bob Nease, the now-retired chief scientist at Express Scripts, a pharmacy benefit manager, as Nease considered using choice architecture to reduce health care costs in 2008. Nease estimated that poor consumer decisions regarding prescriptions, such as forgetting to take a prescribed drug, led to unnecessary medical costs of $300 billion to $400 billion per year. He concluded that encouraging home delivery could eliminate some of these issues, because mail-order deliveries are faster, more convenient and cheaper. 26 Such programs also promote generics over expensive name-brand drugs. 27 Nease ultimately opted for an “active choice” model in which consumers going forward had to select whether they preferred home delivery for maintenance drugs, which would be less pricey, versus pickup at a local pharmacy. In 2009, 40 percent of employees at a large retailer partnering with Express Scripts chose home delivery, compared with 6 percent a year earlier, before the new program was implemented. The switch led to $450,000 in savings for employees and more than $350,000 for the retailer in 2009 alone. More than 400 Express Scripts clients are now enrolled in the program. 28

Behavioral economist Dan Ariely concluded based on experiments that cheating is “infectious.” (Chris Goodney/Bloomberg via Getty Images)

Express Scripts’ corporate headquarters in St. Louis. Express Scripts adopted an “active choice” model that encouraged home delivery of medications, and helped achieve savings in medical costs. (Whitney Curtis/Bloomberg via Getty Images)

Still, some in the field argue that integrating behavioral insights into the private sector can prove more challenging than teasing out effects in a lab. Berman says that in her work, it can be difficult to truly shift behaviors and to measure the effect of real-world changes on corporate policies. 29 In many cases, marketers, designers and product developers are inclined to rely on intuition or feedback from small focus groups, rather than undergoing broad, systematic testing to get to the root of a problem or its solution. Companies also have time and resource constraints that researchers don’t necessarily face in their experiments. “We’ve found through consulting that we’re definitely able to get companies to think about things differently, but actually doing exact intervention or testing is very difficult,” she says. “Companies tend to take a very short-term view of the world of testing and say, ‘I’ll just try something different and see if it works,’ versus ‘What do I want to learn and what are the assumptions I’m testing?’ ” Samson says that while more companies in the corporate world are using these concepts, executives are finding that there’s no “silver bullet” in behavioral economics.

“We’re already past the point where it’s been hyped, and people have come to realize that it’s just one of many tools or perspectives that you can adapt,” he says. “People hoped they could gain a competitive edge applying those principles in their practice. They’ve come to realize you can’t always replicate those effects very easily, and that the world is a lot more complex than they’d hoped.” Background Always Linked

Adam Smith, the father of modern economics, might be best known for inventing the metaphor of the “invisible hand”—still used today to describe how free markets work— but he was also interested in human psychology and the way that behavior affects markets and commerce. Scottish philosopher David Hume and others influenced Smith, as they examined the limits of the human mind and the role of self-interest in society, according to economic historians. 30 In his first book, “The Theory of Moral Sentiments,” written in 1759, Smith examined the struggle between the “passions” and the “impartial spectator” in people’s minds when making decisions. It’s a divide that’s reminiscent of what psychologists refer to as “system one” and “system two” thinking—the balancing of our gut sense and our rational minds. 31 It was early recognition that even the most rational among us also battle with impulsive, emotional internal programming. “There are some situations which bear so hard upon human nature that the greatest degree of self-government … is not able to stifle, altogether, the voice of human weakness, or reduce the violence of the passions to that pitch of moderation, in which the impartial spectator can entirely enter into them,” Smith wrote. 32 Scholars have argued that his work presaged a number of concepts central to behavioral economics, such as loss aversion, the sense that we feel losses more than we do equal gains, and “quasi-hyperbolic discounting,” the idea that people value rewards in the present more than they do in the future. 33 “The pleasure which we are to enjoy ten years hence interests us so little in comparison with that which we may enjoy to-day,” according to Smith. 34 Rise of the Economic Man

As the field of economics developed in the 19th and 20th centuries, scholars began to emphasize ways to quantify economic insights and model behavior. In the universities came a push to elevate the study of economics to be on par with hard sciences like physics and chemistry and to establish theories that could be tested and proved or disproved. 35 A number of economists contributed to this effort, including Vilfredo Pareto, John Hicks, Roy Allen and Paul Samuelson. 36 Many of those models, based on the idea of the self-interested, totally rational economic actor seeking to maximize personal utility or welfare, are still central to the field today. Over time, these simplified assumptions gave rise to the “economic man,” the fully rational creature. The term was actually first used as a criticism of work by the 19th-century English philosopher and political economist John Stuart Mill, and it often continues to be used pejoratively. 37 Samuelson, one of the most prominent economists in the mid-1900s, was particularly instrumental in the move to quantify the discipline, formulating calculations for maximizing utility and establishing a model for how humans discount rewards over time. Despite Samuelson’s own concerns that his findings suggested that people might behave inconsistently as a result of this discounting, his theory took root. “Once Samuelson wrote down this model and it became widely adopted, most economists developed a malady that Kahneman calls theory-induced blindness,” wrote Thaler, referring to psychologist Daniel Kahneman. “In their enthusiasm about incorporating this newfound mathematical rigor, they forgot all about the highly behavioral writings on intertemporal choice that had come before.… They also forgot about Samuelson’s warnings that his model might not be descriptively accurate.” 38 Samuelson also pioneered what’s known as revealed preference theory, which holds that consumers’ choices inherently demonstrate what they want. And this, in turn, “suppressed interest in the psychological nature of preference,” according to several prominent behavioral researchers, including Paul Glimcher and Colin Camerer. 39 In his classic 1953 essay, “The Methodology of Positive Economics,” economist Milton Friedman, one of the most prominent free-market advocates of the last century, defended the use of pared-down assumptions for studying how people operate in the economy. He argued that models should be judged not on their descriptive accuracy —their ability to describe how the world works—but on their predictive power: Truly important and significant hypotheses will be found to have “assumptions” that are wildly inaccurate descriptive representations of reality, and, in general, the more significant the theory, the more unrealistic the assumptions (in this sense). The reason is simple. A hypothesis is important if it “explains” much by little, that is, if it abstracts the common and crucial elements from the mass of complex and detailed circumstances surrounding the phenomena to be explained and permits valid predictions on the basis of them alone. To be important, therefore, a hypothesis must be descriptively false in its assumptions; it takes account of, and accounts for, none of the many other attendant circumstances, since its very success shows them to be irrelevant for the phenomena to be explained. 40 Friedman used a billiards game to illustrate the argument in his essay, which he submitted to the American Economic Review (AER) as part of a long-running debate on whether economic models must conform to realistic behavior in the real world. “Excellent predictions would be yielded by the hypothesis that the billiard player made his shots as if he knew the complicated mathematical formulas” about angles and direction that dictated his shots, Friedman wrote. But in reality “it derives rather from the belief that, unless in some way or other they were capable of reaching essentially the same result, they would not in fact be expert billiard players.” 41 The argument was a powerful one, and “for many economists at the time this settled the issue,” wrote Thaler. “The AER stopped publishing any more rounds of the debate it had been running, and the economists returned to their models free from worry about whether their assumptions were ‘realistic.’ ” 42 A New Way of Thinking

Despite the broad move away from using psychological insights in economic models, a minority of economists resisted the approach. John Maynard Keynes evoked the term “animal spirits” to describe how impulse and emotion can drive human behavior and the broader economy in his landmark 1936 book, “The General Theory of Employment, Interest and Money.” It became part of the basis for his argument about how economic crises unfold and why government spending can be necessary to revive a troubled economy. 43 Meanwhile, a handful of researchers, including George Katona and Herbert Simon, were studying the limits of humankind’s rationality in the 1950s and 1960s. 44 Katona, a Hungarian-born psychologist, spent his career studying connections between economics and psychology and used surveys to analyze consumer sentiment—work that led to the development of modern consumer confidence indexes. 45 Simon is best known for his theory of bounded rationality, the idea that people will often settle for what’s merely good enough, rather than always trying to make perfect, or optimal, decisions. 46 He theorized that people use heuristics, or simple mental shortcuts, when making day-to-day decisions. Those early efforts began to gather steam by the late 1970s. Simon won the Nobel Prize in economics for his work on bounded rationality in 1978. The award came as a Page 8 of 17 Behavioral Economics SAGE Business Researcher ©2021 SAGE Publishing, Inc. All Rights Reserved. surprise, given that he was trained in political science, not economics, and that his work undercut key assumptions in the field, like the idea of full rationality. 47 The following year, two psychologists, Kahneman and Amos Tversky, produced what is considered a landmark study in behavioral economics, called “Prospect Theory: An Analysis of Decision Under Risk.” The paper demonstrated that people behave differently in scenarios where there is uncertainty and risk. The researchers surveyed people about hypothetical gambles to test some of these ideas. 48 Prospect theory applied some of Kahneman and Tversky’s earlier work on heuristics to economic decisions, producing a more descriptive theory that ran counter to some of the basic assumptions economists were using to build their models. Put simply, heuristics are the “mental shotgun” that allows us to make intuitive, snap judgments rather than undertake longer, mentally taxing deliberations. Prospect theory examines some of the systematic ways in which we respond to economic decisions based on those instincts. 49 Unlike the standard model, expected utility theory, which finds that happiness is determined by a person’s level of wealth, prospect theory shifted the focus to look at how people react to gains and losses, or changes in Psychologist Daniel Kahneman won a Nobel Prize in economics 50 wealth. It turns out, for example, that they hate losses twice as much as they enjoy gains. for his work with Amos Tversky on how people behave in situations of uncertainty and risk. (Scott Eells/Bloomberg via “We were not trying to figure out the most rational or advantageous choice; we wanted to find the intuitive Getty Images) choice, the one that appeared immediately tempting,” Kahneman later wrote. 51 Thaler began collaborating with Kahneman and Tversky in the 1980s, despite ongoing opposition from some in the field to these new ideas. In 1987, Thaler started writing an influential series in the Journal of Economic Perspectives called “Anomalies,” which he dedicated to highlighting various incongruities in the field, including those based on behavioral findings. “Dick Thaler lived in an intellectual wilderness in the 1980s,” David Laibson, a professor of economics at Harvard, said in a 2006 interview. “He championed these ideas that economists were deriding. But he stuck to it.” 52 And soon, based on some of these early endeavors, support began to build. In particular, the Alfred P. Sloan Foundation and later the Russell Sage Foundation played a crucial role by hosting meetings and funding early research in behavioral economics in the 1980s and early 1990s. 53 Much of that work was championed by Eric Wanner, who was first a program officer at Sloan and later president of the Sage Foundation, whom Thaler has called “behavioral economics’ founding funder.” 54 The Revolution Takes Hold

Throughout the 1990s and early 2000s, behavioral economics began to garner more serious attention. “The growth rate of behavioral economics, as a serious alternative to models rooted in strong rationality, has been more like a rocket launch, building up a powerful thrust for years and suddenly taking off vertically, than a smooth ascent of an airplane,” Camerer wrote in 2003. “Now we are in takeoff phase and aren’t sure how far the rocket can go or in which direction. But the flight is sure to change economics profoundly and for the better.” 55 Less than a year later, Kahneman took home the Nobel Prize in economics for his work with Tversky on decision-making, including prospect theory, which proved groundbreaking. Tversky would have no doubt shared in the award, but he died in 1996, just 59 years old, and the prize is not awarded posthumously. Kahneman said in an interview that he considered it a joint prize, because “we were twinned for more than a decade.” 56 Numerous other behavioral economists, including Robert Shiller, Matthew Rabin, Sendhil Mullainathan, Esther Duflo and Raj Chetty, have also won major prizes for their work in the field. Shiller won the Nobel Prize in economics for his work on asset bubbles and the stock market in 2013, and others have taken home MacArthur “genius” grants and the John Bates Clark medal, presented to the economist under 40 who has contributed the most to the field. Underscoring the growth and influence behavioral economics has had on the field in recent decades, Thaler served as president of the American Economic Association in 2015 and Shiller followed in 2016. “The lunatics are running the asylum!” Thaler concluded in “Misbehaving.” 57 Current Situation Lessons From the Crisis

Nearly eight years after the financial crisis that triggered the recession of 2007–09, policymakers, the banking industry and scholars are still trying to figure out exactly what went wrong. The race to make money in mortgage lending led to unscrupulous practices, poor decisions and blind spots that seemed obvious once the system began to crumble. The study of behavioral economics is useful for examining the events in the lead-up to the financial crisis and determining what happened during the height of the panic in 2008. Experts have also begun to question why economists largely failed to see the mortgage meltdown coming. “There are so many examples of people taking actions before the crisis that, after the crisis, seem completely crazy,” says Cornell College’s Knoop. “But at the time they were able to justify it through the prism through which they view the world, and I think behavioral economics helps us see that prism.” The strong desire to own a home spurred some people to make poor borrowing decisions, while the banks and regulators fed this behavior and then looked the other way. The credit rating agencies failed to sound the alarm over the decline in loan quality, for fear of losing business to the competition. 58 “The segment of the financial system that initiated loans, and then passed them on, was fragile,” wrote economists George Akerlof and Shiller in their 2009 book, “Animal Spirits.” “It fell. In terms of our animal spirits, confidence disappeared. People became suspicious of transactions that they had previously undertaken to the tune of trillions of dollars. And the story changed. It was now about snake oil. There was no going back.” 59 Akerlof and Shiller have further examined this lack of awareness in “Phishing for Phools,” published in 2015. They argued that economists have failed to incorporate deception into economic models, including the kinds of trickery that play on our psychological vulnerabilities, like those studied in behavioral economics. They pointed to the way some financial institutions packaged lower quality loans with a higher likelihood of default into such hyper-complex securities that they were incredibly difficult to detect. The banks did so because it was profitable to extend credit to borrowers who might not be able to afford the loans and then sell off the securities containing those loans. The banks were driven by incentives that were baked into the system, according to the authors.

“Had we economists appropriately seen free markets as a two-edged sword, we would all but surely have delved into the ways in which financial derivatives and mortgage- backed securities, and also sovereign debt, would turn out badly. More than a handful of us would have sounded the alarm,” they wrote. 60 Still, critics have argued that behavioral economists also largely missed the signs leading up to the crisis, and that the standard economic model still correctly points to the incentives that spurred the bad decisions that caused the economic collapse. “There were incentives, both on the borrower and on the lender side, that these subprime loans would be made available at the lowest interest rates; and there was pressure from the government to do so; and probably those involved did not understand the financial instruments. Now, is it that we have to change our theories radically with respect to their behavioral structure or even switch to a new behavioral framework? There is very little evidence that would support such a move,” said Gary Becker, a prominent economist who has been critical of behavioral economics, in a 2012 interview. 61 Governments around the world, including the United States, are beginning to adopt behavioral science principles to improve program functioning. “This may be an area where the government is actually a little bit ahead of the private sector,” says Harvard’s Beshears. White House Study: Reminders Boost College Enrollment

College enrollment rate for high school graduates with $0 in family contributions, fall 2014

Notes: Data based on study of 4,882 high school graduates from five cities with varying family contributions who were accepted to college. Data used for this graphic apply only to a selection of students from the study with $0 in family contributions. Researchers sent text messages to some graduates, reminding them to complete various steps to successfully enroll in college. The group that received no text messages was the control group in the study. The group that received text messages included graduates who received text messages and graduates whose parents also received text messages.

Source: Benjamin L. Castleman and Lindsay C. Page, "Project Abstract: Summer Melt," U.S. Social and Behavioral Sciences Team, 2014, http://tinyurl.com/zcoggu9

Seventy-two percent of low-income, recent high school graduates who received text messages reminding them to complete college-related tasks during summer 2014 successfully enrolled in college that fall, according to research by the White House’s social and behavioral sciences team. Enrollment rates were nearly 6 points lower for students who received no reminders.

The White House formed a social and behavioral science team in 2014, and issued an executive order in September 2015 instructing federal agencies to explore the use of behavioral techniques in their offices. 62 The behavioral sciences unit, which was made permanent as part of the September 2015 announcement, conducted a number of experiments in its first year. 63 One involved sending text message reminders to students in five cities, encouraging them to complete college-related tasks to stop what’s known as “summer melt”—a phenomenon in which 20 percent to 30 percent of urban students who are accepted to college fail to enroll in the fall. The effort was particularly effective among low-income students; for those from families who were not expected to contribute any money to college, enrollment rates rose 5.7 percentage points, from 66.4 percent to 72.1 percent. 64 In a similar experiment, the team set up an electronic signature box at the beginning of a form used by federal vendors to encourage accurate self-reporting of certain sales on which vendors must pay an “industrial funding” fee. Putting the signature box up front, instead of at the end of the form, increased payment of fees owed to the government by $1.59 million in a single quarter. Vendors who used the form reported a median of $445 more in sales, compared with a control group. 65 The U.K.’s behavioral insights team, which inspired the U.S. effort, has been conducting similar studies since its launch in 2010. The group was partially privatized in 2014 and is now partially owned by Nesta, an independent charity, along with the team’s employees. 66 Related programs can be found in Germany, Singapore, New South

Wales in Australia, Canada, Israel and elsewhere. 67 Advances in Neuroeconomics

Closer to home, behavioral economics is gaining influence on another front: right inside our brains. As neuroscience develops, researchers are increasingly interested in understanding what the brain can tell us about how economic decisions are made. Johannes Haushofer, a professor of psychology and public affairs at Princeton University, has used neuroscience techniques to study the connection between stress, poverty and economic decision-making. He has measured cortisol levels to test the impact of interventions like unconditional cash transfers, rather than just asking people how they feel about the money. “If you ask people how happy they are, they might just tell you they’re pretty happy because they’re grateful for this cash transfer,” he says. “The advantage of measuring stress hormones is you don’t have to worry about that, it’s an objective measure.” Director David Halpern (right) and Deputy Director Owain Service of the U.K.’s behavioral insights team. The U.K. team Still, he says that neuroeconomics might be more limited when it comes to bolstering economic theory, inspired a similar White House effort. (Carl Court/AFP/Getty particularly regarding imaging different parts of the brain. Images) “Neuroscientific explanations are generally explanations about brain areas interacting—where does something happen, how does it happen—and if we want to learn about behavior to inform economic theory, it’s often better to study behavior directly,” Haushofer says. Others are taking a longer view about how these insights could advance economics down the line, given that the field is still in early days. “Anybody who asks us how to design economic policy based on some [MRI] image is like somebody asking, in 1910, how to use chemistry to get us to the moon when the rockets capable of this hadn’t even been invented yet,” Jonathan Cohen, co-director of the Princeton Neuroscience Institute at Princeton University, said in a 2010 interview. “So it’s a long path we’re on.” 68 Looking Ahead Integrating Insights

Now that behavioral economics has established itself within the field, the next step for researchers, policymakers and business executives is to find ways to continue to integrate its insights into existing economic theories and real-world applications. “It’s infused in how people think,” says Clifton Green, an associate professor of finance at Goizueta Business School at Emory University. He estimates, for example, that 15 percent to 20 percent of Ph.D. dissertations in finance these days have behavioral aspects to them. “Usually what happens from an empirical perspective is you’ll see this evidence, and you have your interpretation,” he adds. “People will say, there’s four other interpretations and for your preferred interpretation, you need to rule out those other ones. Often times at least one of those interpretations is behavioral, if not the preferred one.” Of course, challenges remain, whether finding ways to quantify psychological insights so they can be integrated into economic models or putting those theories into practice in the boardroom. “Some decisions are harder to systematically study, because they happen less frequently—so launching a new marketing campaign, that’s pretty hard to quantify,” says Beshears. People Feel Monetary Losses More Than Gains

Psychological value corresponding to monetary gains or losses

Source: Daniel Kahneman, “Thinking, Fast and Slow,” 2011.

Losing money is about twice as painful as gaining it is pleasurable, according to a principle known in behavioral economics as loss aversion. In the above example based on a model by behavioral psychologist Daniel Kahneman, a loss of $2,000 will create twice as much negative psychological value as the positive psychological value generated by a $2,000 gain. In line with this principle, people presented with $1,000 and options to either receive a guaranteed $500 extra or to gamble for $1,000 more with 50 percent odds are more likely to choose the first option because of the certainty involved. In a second example, individuals presented with $2,000 and options to either lose $500 guaranteed or risk losing $1,000 with 50 percent odds are more likely to choose the latter because they could avoid losing any of the money.

Still, behavioral economists could find a friend in big data going forward, as those in business and government find ways to harness the power of data analytics and combine them with tools like nudges. “When the ultimate goal is behavior change, predictive analytics and the science of behavioral nudges can serve as two parts of a greater, more effective whole,” wrote James Guszcza, the U.S. chief data scientist for Deloitte Consulting in 2015. 69 He points to President Obama’s 2012 re-election campaign, in which workers combined the approaches to help turn out the vote. Operatives built sophisticated voting models to help volunteers prioritize voters who were most likely to be persuaded to back Obama. At the doorstep, volunteers were instructed to employ several behavioral tactics to strengthen the likelihood that the target would head to the polls on Election Day. Potential voters were asked to sign commitment cards with Obama’s face on them and describe a specific plan for getting to their voting center. They were also told about their neighbors’ intentions to vote, invoking what’s known as social proof. At the same time, Thaler, the early behavioral economist, laments that more work is needed around the psychology of macroeconomics, which focuses on the functioning of the entire economy, as opposed to microeconomics, or the study of individual economic decisions or markets. He argues that behavioral work in this area could help policymakers better understand how to stimulate the economy in times of crisis, such as through tax cuts.

“One supposedly irrelevant detail these policymakers should consider is whether the cut should come in a lump sum or be spread out over the course of the year,” he wrote. “Without evidence-based models of consumer behavior, it is impossible to answer that question.” 70 About the Author

Victoria Finkle is a freelance journalist based in Washington, D.C., who focuses on business, banking and public policy. She has written for the New York Times, Inc. magazine, Bloomberg BNA and Washington Monthly, and previously worked as a staff writer for the American Banker newspaper, covering Capitol Hill and consumer finance. Chronology

1700s–1850s Early thinkers consider psychological underpinnings to economic decisions. 1759 Adam Smith publishes “Theory of Moral Sentiments,” in which he first uses the phrase “the invisible hand” to describe economic markets. He also discusses how humans balance rational and emotional factors when making decisions and reveals what some believe to be key insights into future behavioral economics theories. 1860s–1960s Economists seek to quantify their insights and make the field more scientific. 1897 Italian economist Vilfredo Pareto dismisses the idea that psychology has a place in economics. 1937 Paul Samuelson develops the discounted utility model, based on the idea that humans value rewards in the future less than in the present. A year later he publishes similarly groundbreaking work on revealed preference theory, an alternative to utility theory that suggests consumer preferences are demonstrated through purchases. 1953 Milton Friedman writes “The Methodology of Positive Economics,” which becomes the foundational defense for the assumptions underpinning the “economic man.” 1970s–1980s Behavioral economics takes root. 1978 Herbert Simon, a political scientist, wins the Nobel Prize in economics for his 1950s study of “bounded rationality,” the idea that people often make decisions that are “good enough” rather than trying to maximize their utility. 1979 Psychologists Daniel Kahneman and Amos Tversky publish their landmark paper, “Prospect Theory: An Analysis of Decision under Risk,” which demonstrated that people behave differently in scenarios where there is uncertainty and risk. 1984 The Sloan Foundation formally begins funding work in behavioral economics and holding conferences on the topic. 1987 Economist Richard Thaler, one of the first behavioral economists, begins writing his popular “Anomalies” series in the Journal of Economic Perspectives. 1990s–Present Behavioral economics goes mainstream. 1994 The Nobel Prize in economics is awarded to Reinhard Selten, who worked on problems of decision-making and human behavior through experimental economics and game theory. 1998 Thaler and Shlomo Benartzi begin their work on “Save More Tomorrow,” a program that uses behavioral economics principles to encourage retirement savings. 2000 Matthew Rabin, an early behavioral economist, wins a MacArthur “genius” grant for his research on self-control and fairness. 2002 The Nobel Prize in economics is awarded to Daniel Kahneman for his work on prospect theory. Sendhil Mullainathan wins a MacArthur genius grant for his work on behavioral economics, including applications for policy work in developing countries. 2005 Journalist Steven Dubner and economist Steven Levitt write “Freakonomics,” a popular economics book that uses some behavioral insights and goes on to become a surprise best-seller. 2008 The financial crisis hits, causing many in the economics profession to question what went wrong and why nobody saw the crash of the housing market coming.… Economist Thaler and legal scholar Cass Sunstein publish “Nudge: Improving Decisions about Health, Wealth, and Happiness,” and leading behavioral economist Dan Ariely releases “Predictably Irrational: The Hidden Forces That Shape Our Decisions,” both of which rise to the top of the best-seller list. 2009 Esther Duflo wins a MacArthur “genius” grant for behavioral and experimental work on how poverty influences decision-making in developing countries. 2010 The U.K. government establishes the behavioural insights team, the first organization of its kind, which looks at ways to improve public policy from within, based on behavioral research. 2012 Raj Chetty wins a “genius” grant for his work looking at how behavior can be used to design public policy. 2013 Robert Shiller receives the Nobel Prize in economics for his work on asset bubbles and “irrational exuberance” in the stock market. Perhaps ironically, he shares the award with Eugene Fama, father of the “efficient-market hypothesis,” and another financial economist, Lars Hansen. 2014 The White House forms its own social and behavioral sciences team, modeled after the U.K. program. 2015 Thaler publishes “Misbehaving: The Making of Behavioral Economics,” which serves as a history of the field and a personal memoir.

Resources

Bibliography

Books

Akerlof, George A., and Robert J. Shiller, “Phishing for Phools: The Economics of Manipulation and Deception,” Princeton University Press, 2015. Two prominent economists argue that economics has failed to incorporate how deception and trickery influence markets. Kahneman, Daniel, “Thinking, Fast and Slow,” Farrar, Straus and Giroux, 2011. This book sums up much of the groundbreaking work by psychologist Kahneman and his research partner Amos Tversky on judgment and decision-making, including applications for economics. Mullainathan, Sendhil, and Eldar Shafir, “Scarcity: Why Having Too Little Means So Much,” Picador, 2013. A look at the behavioral economics of poverty and development by two researchers at Harvard and Princeton, respectively. Nease, Bob, “The Power of Fifty Bits: The New Science of Turning Good Intentions Into Positive Results,” HarperCollins, 2016. The former chief scientist at Express Scripts, a pharmacy benefits manager, explains how corporations and others in the business world can apply behavioral strategies to business. Thaler, Richard H., “Misbehaving: The Making of Behavioral Economics,” W.W. Norton & Co., 2015. One of the first behavioral economists traces the history of the field and his contributions to it. Thaler, Richard H., and Cass R. Sunstein, “Nudge: Improving Decisions About Health, Wealth, and Happiness,” Penguin Books, 2008. A classic in the literature, this book argues that policymakers and business leaders should use “choice architecture” to better design everything from cafeteria lines to retirement savings plans to help consumers make better decisions.

Articles

Ariely, Dan, “The End of Rational Economics,” Harvard Business Review, July–August 2009, http://tinyurl.com/h69mryb. A leading researcher in behavioral economics argues that the 2007–09 financial crisis should mark the end of trust in classical economic theory and reviews studies about why people cheat. Berman, Kristen, “How Startups Should Use Behavioral Economics,” Tech Crunch, Dec. 7, 2015, http://tinyurl.com/nq28tsh. A behavioral economist argues that startups and designers should integrate behavioral insights into their processes. Harford, Tim, “Behavioural Economics and Public Policy,” Financial Times, March 21, 2014, http://tinyurl.com/jctrmyf. Article examines some current fights over the relevance of behavioral economics and its future. Lambert, Craig, “The Marketplace of Perceptions,” Harvard Magazine, March–April 2006, http://tinyurl.com/zjospet. The deputy editor of Harvard Magazine comprehensively reviews the rise of behavioral economics. Lowenstein, George, and Peter Ubel, “Economics Behaving Badly,” The New York Times, July 15, 2010, http://tinyurl.com/23bn2ru. Two leading researchers in the field criticize the belief that behavioral economics is a silver bullet. Porter, Eduardo, “Nudges Aren’t Enough for Problems Like Retirement Savings,” The New York Times, Feb. 23, 2016, http://tinyurl.com/htk2ajs. Article explores why behavioral economics interventions sometimes fall short. Thaler, Richard H., and Sendhil Mullainathan, “How Behavioral Economics Differs from Traditional Economics,” The Concise Encyclopedia of Economics, http://tinyurl.com/6l36hpy. Two economists provide an overview of behavioral economics and its history.

Reports and Studies

“2015 Annual Report,” White House Social and Behavioral Sciences Team, http://tinyurl.com/zuxhxcg. An annual report reviews the White House team’s first year of studies, including test results from a variety of interventions. Beshears, John, Patrick Rooney and Jenny Sanford, “Express Scripts: Promoting Prescription Drug Home Delivery (A) and (B),” Harvard Business School Case 916-026, February 2016, http://tinyurl.com/zntucqj. A case study examines Bob Nease’s decision to change the default option for home delivery of certain prescriptions during his time as chief scientist at Express Scripts. Samson, Alain, ed., “The Behavioral Economics Guide 2015,” http://tinyurl.com/nulvsm3. This guide provides an overview of behavioral economics literature as well as essays from top practitioners on a host of related topics. It also includes an extensive glossary of relevant terms. The Next Step

Company Strategy

Dholakia, Utpal M., “Why Nudging Your Customers Can Backfire,” Harvard Business Review, April 15, 2016, http://tinyurl.com/jan6kgv. Some sellers have successfully steered customers to buy certain products by using nudge marketing, although others have failed because some consumers see such efforts as condescending, says a marketing professor at Rice University’s graduate business school. Ember, Sydney, “Life Insurance Tries to Lighten Up,” The New York Times, March 25, 2016, http://tinyurl.com/jxphxgx. Several life insurance companies have undertaken advertising campaigns with positive messaging to fight consumers’ negative impressions linking their products to mortality. Whitman, Elizabeth, “The ‘Natural’ Food Label Is A Lie, And Most Customers Have No Idea,” International Business Times, Jan. 27, 2016, http://tinyurl.com/h53e877. More food companies are labeling products as “natural” because the U.S. Food and Drug Administration does not define the term and consumers are more likely to buy such labeled products, according to the director of food safety for Consumer Reports.

Finance

Belsky, Gary, “Why We Think We’re Better Investors Than We Are,” The New York Times, March 25, 2016, http://tinyurl.com/hxkmoga. Overconfidence and biases toward optimism and belief in one’s ability to outperform past investments, among other factors, lead amateur investors to continue making risky decisions, says an author who writes about decision-making and consumer behavior.

Singal, Jesse, “Don’t Let Your Brain Throw Away All of Your Money,” New York Magazine, Jan. 27, 2016, http://tinyurl.com/zpsbh3f. Ordinary investors should put money in index funds and other low-risk investments, but many forgo these for high-risk options and are then unwilling to sell poorly performing stocks for fear of losing money, says a social sciences professor at the University of Chicago. Wang, Penelope, “How a Bowl of Cashews Changed the Way You Save for Retirement,” Time, May 11, 2015, http://tinyurl.com/hff5k7e. Many people overestimate their self-control for spending and save less than they should, but employers can help them save more by automatically enrolling them in retirement plans, says a behavioral finance professor at the University of Chicago’s Booth School of Business.

Government Policies

Bunch, Joey, “Democrats offer bill to grant options on state tax refunds,” The Denver Post, April 18, 2016, http://tinyurl.com/j9hkndo. A Colorado bill co-sponsored by Democratic state representatives would allow taxpayers to receive refunds in multiple checking or savings accounts rather than as a lump sum, which proponents say would encourage families to save the money. Nussbaum, Dave, “The science of human behavior is reshaping the US government,” Quartz, Nov. 10, 2015, http://tinyurl.com/nk9f4oq. President Obama signed an executive order in September 2015 encouraging agencies to boost efficiency by applying behavioral science findings to new or existing federal programs. Rutter, Tamsin, “The rise of nudge – the unit helping politicians to fathom human behavior,” The Guardian, July 23, 2015, http://tinyurl.com/ztog9r2. A U.K. government- sponsored team has helped the country boost organ donor and army enrollment and increase police-force diversity, among other outcomes, by researching nudge tactics later implemented in government policies.

Poverty

Nolan, Hamilton, “Behavioral Science and Poverty,” Gawker, June 1, 2015, http://tinyurl.com/qh9jrsw. Anti-poverty programs should improve communication with participants, reduce sign-up paperwork and have accessible locations and operating hours, particularly for working people, says a report by a behavioral economics- focused nonprofit. Semuels, Alana, “When the Government Tells Poor People How to Live,” The Atlantic, Dec. 14, 2015, http://tinyurl.com/gmlad74. The Worcester Housing Authority mandated in spring 2015 that most state-subsidized public-housing residents work or attend school to continue receiving housing benefits, a policy change that the agency’s director said is meant to help lift residents from poverty. Zweig, Jason, “The Anti-Poverty Experiment,” The Wall Street Journal, June 5, 2015, http://tinyurl.com/o8ny5p8. Anti-poverty groups and agencies in the United States and other countries are working with psychology and economic researchers to test incentive programs that aim to help poor people save more money. Organizations

American Economic Association 2014 Broadway, # 305, Nashville, TN 37203 615-322-2595 www.aeaweb.org Academic society for U.S.-based economists that publishes several top scholarly journals. The Behavioural Insights Team 33 Greycoat St., Westminster, London, SW1P 2QF, UK [email protected] http://www.behaviouralinsights.co.uk The U.K.’s behavioral economics unit that inspired the White House’s effort. Center for Advanced Hindsight 2024 W. Main St., Durham, NC 27705 919-660-7703 http://advanced-hindsight.com Economist Dan Ariely’s research lab at Duke University that studies behavioral economics. Economic Science Association School of Information, University of Michigan, 105 S. State St., Ann Arbor, MI 48109 734-764-9488 https://www.economicscience.org/esa/index.html Professional association for experimental economists. European Association for Decision Making Leeds University Business School, Maurice Keyworth Building, University of Leeds, Leeds, LS2 9JT, UK 44 (0)113 343 4473 http://eadm.eu Association for researchers who study decision-making and judgment. International Association for Research in Economic Psychology Servicebox 422, N-4604, Kristiansand, Norway 47 38 14 15 12 http://www.iarep.org Scholarly group for researchers that focuses on the intersection of economics and psychology. Society for the Advancement of Behavioral Economics PO Box 8130, 6700 EW Wageningen, The Netherlands 31.317.483897 http://www.sabeonline.org Behavioral economics association for researchers.

[1] For background on stickK, see http://tinyurl.com/gpdlcoe. [2] All data provided by stickK. [3] Richard H. Thaler and Sendhil Mullainathan, “How Behavioral Economics Differs from Traditional Economics,” The Concise Encyclopedia of Economics, http://tinyurl.com/6l36hpy. [4] Richard H. Thaler and Cass R. Sunstein, “Nudge: Improving Decisions About Health, Wealth, and Happiness,” 2008, pp. 6-7. [5] Daniel Kahneman, “Thinking, Fast and Slow,” 2011, pp. 280-283. [6] John Fleming and James Harter, “The Next Discipline: Applying Behavioral Economics to Drive Growth and Profitability,” Gallup, Sept. 22, 2012, p. 10, http://tinyurl.com/zd66wa8. [7] Richard H. Thaler, “Opting in vs. Opting Out,” The New York Times, Sept. 26, 2009, http://tinyurl.com/yenra2j. [8] Richard H. Thaler, “Misbehaving: The Making of Behavioral Economics,” 2015, p. 358. [9] Nathan Berg, “Behavioral Economics,” in “21st Century Economics: A Reference Handbook,” edited by Rhona Free, 2010, chp. 84, p. 873. [10] Tim Harford, “Behavioural Economics and Public Policy,” Financial Times, March 21, 2014, http://tinyurl.com/jctrmyf. [11] Thaler and Sunstein, “Nudge: Improving Decisions About Health, Wealth, and Happiness,” op. cit., pp. 5-6. [12] Ibid., p. 5. [13] Nari Rhee and Ilana Boivie, "The Continuing Retirement Savings Crisis," National Institute on Retirement Security, March 2015, http://tinyurl.com/pkoxwfq. [14] Thaler and Sunstein, “Nudge: Improving Decisions About Health, Wealth, and Happiness,” op. cit., p. 116. [15] Eduardo Porter, “Nudges Aren’t Enough for Problems Like Retirement Savings,” The New York Times, Feb. 23, 2016, http://tinyurl.com/jxp3qln; see also George Lowenstein and Peter Ubel, “Economics Behaving Badly,” The New York Times, July 14, 2010, http://tinyurl.com/23bn2ru. [16] Cäzilia Loibl et al., “Testing Strategies to Increase Saving and Retention in Individual Development Account Programs,” Social Science Research Network, Feb. 20, 2016, http://tinyurl.com/ju43qbw. [17] Vania Phtidis and Sophie Sabbage, “Beyond Nudge: it’s time to call forth people’s willingness to change,” The Guardian, Oct. 6, 2011, http://tinyurl.com/gmhceeu. [18] Dan Ariely, “The End of Rational Economics,” Harvard Business Review, July-August 2009, http://tinyurl.com/h69mryb. [19] Dan Ariely, “How Honest People Cheat,” Harvard Business Review, Jan. 29, 2008, http://tinyurl.com/zztp7df. [20] Ibid. [21] Ariely, “The End of Rational Economics,” op. cit. [22] Ibid. [23] Ariely, “How Honest People Cheat,” op. cit. [24] “The Maddest Men of All,” Freakonomics, February 2015, http://tinyurl.com/h5996no. [25] Fleming and Harter, op. cit., p. 10. [26] John Beshears, Patrick Rooney and Jenny Sanford, "Express Scripts: Promoting Prescription Drug Home Delivery (A)," Harvard Business School Case 916-026, February 2016, http://tinyurl.com/zntucqj. [27] Ibid. [28] Ibid. [29] Kristen Berman, “How Startups Should Use Behavioral Economics,” Tech Crunch, Dec. 7, 2015, http://tinyurl.com/nq28tsh. [30] Robert Formaini, “David Hume: Foundations of the Classical School of Economics,” Economic Insights, Federal Reserve Bank of Dallas, http://tinyurl.com/zowfm3b. [31] Hersh Shefrin, “The Behavioral Paradigm Shift,” Revista de Administração de Empresas, January/February 2015, http://tinyurl.com/htadxqu. [32] Nava Ashraf, Colin F. Camerer and George Loewenstein, “Adam Smith, Behavioral Economist,” Journal of Economic Perspectives, Summer 2005, http://tinyurl.com/hl5l7h5. [33] Ibid. [34] Thaler, “Misbehaving: The Making of Behavioral Economics,” op. cit., p. 88. [35] Colin F. Camerer, “Behavioral economics: Reunifying psychology and economics,” Proceedings of the National Academic of Sciences, Sept. 14, 1999, http://tinyurl.com/z9cub85. [36] Luigino Bruni and Robert Sugden, “The Road Not Taken: How Psychology Was Removed from Economics and How It Might Be Brought Back,” The Economic Journal, January 2007, http://tinyurl.com/hqlxzwb; see also Thaler, “Misbehaving: The Making of Behavioral Economics,” op. cit., chp. 11. [37] Joseph Persky, “Retrospectives: The Ethology of Homo Economicus,” Journal of Economic Perspectives, Spring 1995, http://tinyurl.com/jo82zd9.

[38] Thaler, “Misbehaving: The Making of Behavioral Economics,” op. cit., p. 93. [39] Paul W. Glimcher et al., “Introduction: A Brief History of Neuroeocnomics,” in “Neuroeconomics: Decision Making and the Brain,” 2009, http://tinyurl.com/z4khklp. [40] Milton Friedman, “The Methodology of Positive Economics,” 1953, http://tinyurl.com/hbfzo26. [41] Ibid. [42] Ibid., p. 46. [43] George A. Akerlof and Robert J. Shiller, “Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism,” 2009, pp. 3-4. [44] Hamid Hosseini, “George Katona: A founding father of old behavioral economics,” Journal of Socio-Economics, November 2011, http://tinyurl.com/zv99tvu. [45] Jan Logemann, “George Katona: Behavioral Economist and Consumer Researcher,” Transatlantic Perspectives, February 2011, http://tinyurl.com/jby5nnb. [46] Thaler and Mullainathan, op. cit. [47] Leonard Silk, “Nobel to Simon Was Surprise,” The New York Times, Nov. 9, 1978, http://tinyurl.com/hjfgdlo. [48] Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision Under Risk,” Econometrica, March 1979, pp. 263-292, http://tinyurl.com/h2vkn2u. [49] Kahneman, “Thinking, Fast and Slow,” op. cit., p. 99. [50] Thaler, “Misbehaving: The Making of Behavioral Economics,” op. cit., chp. 4. [51] Kahneman, “Thinking, Fast and Slow,” op. cit., p. 271. [52] Craig Lambert, “The Marketplace of Perceptions,” Harvard Magazine, March-April 2006, http://tinyurl.com/zjospet. [53] Floris Heukelom, “A Sense of Mission: The Alfred P. Sloan and Russell Sage Foundations’ Behavioral Economics Program, 1984–1992,” working paper, April 2011, http://tinyurl.com/jm3zjok. [54] Thaler, “Misbehaving: The Making of Behavioral Economics,” op. cit., p. 154. [55] Colin F. Camerer, “The behavioral challenge to economics: Understanding normal people,” prepared for Federal Reserve Bank of Boston meeting, June 2003, http://tinyurl.com/zfwlfcc. [56] Erica Goode, “A Conversation With Daniel Kahneman; On Profit, Loss and the Mysteries of the Mind,” The New York Times, Nov. 5, 2002, http://tinyurl.com/grfat5n. [57] Thaler, “Misbehaving: The Making of Behavioral Economics,” p. 347. [58] Hersh Shefrin and Meir Statman, “Behavioral Finance in the Financial Crisis: Market Efficiency, Minsky, and Keynes,” Russell Sage Foundation, November 2011, pp. 99–135, http://tinyurl.com/qekodv9. [59] Akerlof and Shiller, “Animal Spirits: How Human Psychology Drives the Economy,” p. 90. [60] George A. Akerlof and Robert J. Shiller, “Phishing for Phools: The Economics of Manipulation and Deception,” 2015, pp. 23-24 and 165. [61] Catherine Herfeld, “The potentials and limitations of rational choice theory: An interview with Gary Becker,” Erasmus Journal for Philosophy and Economics, Spring 2012, http://tinyurl.com/zmlc7wd. [62] “Fact Sheet: President Obama Signs Executive Order; White House Announces New Steps to Improve Federal Programs by Leveraging Research Insights,” The White House, Sept. 15, 2015, http://tinyurl.com/pk8fv77. [63] “Annual Report 2015,” White House Social and Behavioral Sciences Team, http://tinyurl.com/zuxhxcg. [64] Ibid. [65] Ibid. [66] For background, see the Behavioural Insights Team, http://tinyurl.com/nbdk8ly. [67] David Halpern, “Nudging for Good,” Sept. 1, 2015, http://tinyurl.com/hmpqzls. [68] Ted O’Callahan, “What Is Neuroeconomics?” Yale School of Management, Jan. 15, 2010, http://tinyurl.com/gnbuw76. [69] James Guszcza, “The Last Mile Problem: How data science and behavioral science can work together,” Deloitte Review, Jan. 26, 2015, http://tinyurl.com/j9orqrp. [70] Thaler, “Misbehaving: The Making of Behavioral Economics,” op. cit., p. 351.

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