The Ghost in the Machine

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The Ghost in the Machine
Laura Taylor Georgia State University
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The Charge

• Behavioral Economics is it relevant for
  Environmental Policy?
• not
• Behavioral Economics is it relevant for
  Environmental Economists?

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Example Hyperbolic Discounting

• HD implies people make far-sighted decisions when
  costs/benefits occur in future but make
  relatively short-sighted decisions when some
  costs/benefits are immediate
• Creates a time inconsistency
• Prospectively you would wish to make far-sighted
  decisions, but when future arrives, you choose
  short-sighted decisions.

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Relevance forEnvironmental Policy?

• Prince and Shawhan
• Do individuals exhibit behavior consistent with
  HD when acting in a group context (voting for
  outcomes)?
• Yes. (although a little less so)
• Lab evidence suggests that this could be
  important for environmental policy contexts.

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Relevance forEnvironmental Policy?

• Can you think of an actual past instance of a
  group favoring some kind of future investment,
  but then favoring it less as its time approaches,
  even though nothing changed to significantly
  worsen the (undiscounted) costs or benefits of
  the investment? When I say "investment," I mean
  any action with an up-front cost (of any kind)
  followed by benefits.

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Is this Phenomenon of 2nd Order Importance?

• A phenomenon may be robust, but trivial in
  naturally occurring settings.
• A phenomenon may be substantive, but not robust
  to relevant environments.

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Is the anomaly of hyperbolic discounting
important?

• Della Vigna and Malmendier, QJE, 2004
• If consumers have time-inconsistent preferences,
  profit maximizing firms should respond and tailor
  contracts and pricing schemes in response.
• Firms would not respond to consumer deviations
  that are not systematic or limited to small
  stakes.

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Setup

• Consider two types of individuals (as compared to
  time consistent agents)
• Quasi-hyperbolic discounting self-aware
• Quasi-hyperbolic discounting unaware
• Consider two types of goods
• Investment goods (cost in t, benefit in tx)
• Time inconsistency leads to under-consumption
• Leisure goods (benefit in t, cost in tx)
• Time inconsistency leads to over-consumption

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Contract DesignInvestment Goods

• Firms will charge a fixed fee and then price
  consumption below marginal cost for
  time-inconsistent consumers.
• Naïve overestimate the value of the future
  discount
• Sophisticates demand commitment device to
  increase future consumption low per-use fee is
  that device.
• Firms price at marginal cost for time-consistent,
  rational (sophisticated) consumers.
• Result holds for monopolistic or competitive
  firms.

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Contract DesignLeisure Goods

• Firms charge low (even negative) initial fees,
  and then price consumption above marginal cost
  for time-inconsistent consumers.
• Naïve underestimate future consumption
  contracts exploit this
• Sophisticates demand commitment device to
  decrease future consumption high per-use fee is
  that device.
• Firms price at marginal cost for time-consistent,
  rational consumers.

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Evidence?

• Contracts in several industries are consistent
  with models of naïve (or sophisticated) consumers
  with time-inconsistent preferences.
• Investment Good Health Clubs
• Initial fixed fees with pricing below MC (p0)

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Evidence?

• Bridget Jones Diary
• Sat, 31 Dec. New Years Resolutions. I WILL
  ... go to the gym three times a week not merely
  to buy sandwich.
• Mon, 28 April. Number of gym visits so far this
  year 1, cost of gym membership per year 370
  cost of single gym visit 123.
• Leisure Good Credit Cards
• Zero or negative initial fees
• Pricing above marginal cost

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Evidence?

• Strong Hypothesis Tests
• Model predicts
• If X is true, then Y would be observed
• If Z is true, then M would be observed
• Collect data and test it.

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Left wondering Are behavioral anomalies of
2nd order importance for environmental policy?
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Where is the heavy lifting?

• Carbon taxes / gas taxes
• Impact fees
• Development infrastructure
• Storm water utilities
• Removal of perverse subsidies
• use-it or lose-it water permits
• production subsidies
• Pricing water

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Simple Battle of Efficient Water Allocation

• Georgia Water Coalition
• Some lawmakers still believe that allowing the
  sale of water is the best way to allocate it in
  times of shortage. Theyre wrong. If the market
  determines water use, water will be sold to the
  highest bidders...
• Georgia Sierra Club / Upper Chattahoochee
  Riverkeeper
• "This act put a dollar value on water, and
  undoing that will be extremely important."

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Behavioral EconomistNot so fast! What about
Israel DC exp?

• Daycare problem
• Late parents
• Economist solution
• Price being late
• Randomized experiment, designed by the economists
• Outcome Late pick-ups went up

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How to Rationalize the Data?

• The fine normalized the behavior.
• Application to Environmental Policy
• Voluntary water restrictions versus water pricing
  during droughts
• Could you see water use increase with pricing?

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Not so fast!

• Fee instituted at day care was 3/child (flat
  rate per day).
• Pricing in the real world?
• Between 1 and 2 per minute for late pickup ? no
  late pickups!
• Lesson Learned? Dont let an economist pick your
  pricing strategy.

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Lesson Learned?

• The luxury of feedback, learning, and multiple
  adjustments absent in many policy contexts.
• Assumption of marginal adjustments moving one
  toward the optimum may be a bad one.

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Behavioral Economics is it relevant for
Environmental Policy?
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Vernon Smith

• Many psychologists appear to find irrationality
  everywhere, and many economists appear to see the
  findings as everywhere irrelevant.
• most standard theory provides a correct first
  approximation in predicting motivated behavior

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The Charge Reformulated

• Demonstrate the importance of Behavioral
  Economics for environmental policy

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• In mainstream economics, the concept of rational
  behavior is defined as a social construct an
  economic choice within the social institution of
  mercantile exchange not an isolated decision
  made in a private bubble.

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The Ghost in the Machine

• Revisited and Redefined

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Wikipedia Decision Making and Behavioral Bias

• Over seventy different cognitive biases are
  identified, including
• endowment effect, focusing effect, hyperbolic
  discounting, impact bias, information bias, loss
  aversion, rosy retrospection (not my dad!),
  status quo bias, ambiguity effect, anchoring,
  availability heuristic, hindsight bias,
  egocentric bias (coauthor bias), halo effect,
  projection bias, notational bias, recency effect,
  primacy effect, polarization effect, illusion of
  transparency, in-group bias, overconfidence...

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Is this Humanity?
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The Ghost in the Machine