Applying Behavioral Economics

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Applying Behavioral Economics

  1. 1. John E. Padilla, Senior Associate The Annie E. Casey Foundation
  2. 2. <ul><li>Understanding “Behavioral Economics” </li></ul><ul><li>What it means to you as a service provider </li></ul><ul><li>How customers exhibit behavioral economics every day </li></ul><ul><li>Using behavioral economics to “position” your program offerings </li></ul><ul><li>Q&A </li></ul>
  3. 3. <ul><li>Engaging participants in our programs </li></ul><ul><li>Understanding barriers to “success” </li></ul><ul><ul><li>Workforce </li></ul></ul><ul><ul><li>Asset-building </li></ul></ul><ul><ul><li>Others </li></ul></ul><ul><li>Delivering effective financial education programs </li></ul><ul><li>Understanding “choice architecture” and using it! </li></ul><ul><li>Design programs so they might work the way we hope they will </li></ul><ul><li>Staff, clients, participants are on common ground! </li></ul>
  4. 5. <ul><li>Would you rather receive $100 right now or $101 in a week? </li></ul><ul><li>How about $100 a year from now and $101 in a year and a week from now? </li></ul><ul><li>You need a short-term $500 loan (30 days): </li></ul><ul><li>Would you go to a bank and borrow at 15% interest, or would you borrow it from your friend and give them $50 (10%) for doing you the favor? </li></ul><ul><li>“ 10% don’t survive the operation!” </li></ul>
  5. 6. <ul><li>Behavior is the result of: </li></ul><ul><ul><li>Far sighted cost-benefit impact calculations </li></ul></ul><ul><ul><li>What would I buy with the loan? </li></ul></ul><ul><ul><li>What benefits would that provide? </li></ul></ul><ul><li>How would these interest payments affect me? </li></ul><ul><ul><ul><li>Easy implementation of resulting choice </li></ul></ul></ul><ul><ul><ul><li>“ Go to the bank on Tuesday” </li></ul></ul></ul><ul><li>Key missing variable on letter: ???? </li></ul>
  6. 7. <ul><li>Choice is the result of many “inconsequential” contextual details </li></ul><ul><ul><li>– My mood when receiving the letter </li></ul></ul><ul><ul><ul><li>What feelings might the photo evoke? </li></ul></ul></ul><ul><ul><li>– Perceived complexity of the choice </li></ul></ul><ul><ul><ul><li>Does the table ease or complicate my thinking? </li></ul></ul></ul><ul><ul><li>– The dimensions I evaluate on </li></ul></ul><ul><ul><ul><li>Lottery => “Do I need a cell phone?” </li></ul></ul></ul><ul><li>Follow through on choice not guaranteed </li></ul><ul><ul><li>– Do I forget or procrastinate in getting to the bank? </li></ul></ul>
  7. 8. <ul><li>Behavioral economics and behavioral finance are closely related fields that have evolved to be a separate branch of economic and financial analysis which applies scientific research on human and social, cognitive and emotional factors to better understand economic decisions by, consumers, borrowers, investors, and how they affect market prices and the allocation of resources. </li></ul><ul><li>  </li></ul><ul><li>The field is primarily concerned with the bounds of rationality (selfishness, self-control) and typically integrates insights from psychology with classical economic theory . </li></ul>(source: Wikipedia)
  8. 9. <ul><li>Fastest growing field in economics </li></ul><ul><li>Behavioral economics can be about choices and how people can make better choices </li></ul><ul><li>Bounded rationality – Assumes people have limited time and capacity to fully assess a decision. </li></ul><ul><li>Decision making is less than fully rational. People are prone to make predictable and avoidable mistakes. </li></ul><ul><li>At the same time, decision making is systematic and amenable to scientific study. </li></ul>
  9. 10. <ul><li>Understanding how people make and process decisions can help: </li></ul><ul><ul><li>Gain insights into the emotional underpinnings of a person’s decision-making </li></ul></ul><ul><ul><li>Create more effective messages for participants </li></ul></ul><ul><ul><li>Structure programs so they have a better probability of achieving your desired results </li></ul></ul><ul><ul><li>Change the way you try to motivate participants (incentives and disincentives) </li></ul></ul><ul><ul><li>Influence the decisions program participants make </li></ul></ul>
  10. 11. <ul><li>Heuristics: People often make decisions based on approximate rules of thumb , not strictly rational analysis. </li></ul><ul><li>Framing: The way a problem or decision is presented to the decision maker will affect his action. </li></ul><ul><li>Market inefficiencies: There are explanations for observed market outcomes that are contrary to rational expectations and market efficiency. These include mis-pricings, non-rational decision making, and return anomalies. </li></ul><ul><ul><ul><li>For example: Which TV has more value? (42” flat screen or 50” flat screen) Which one do I buy? </li></ul></ul></ul>
  11. 12. <ul><li>Framing . Allowing the way a decision is presented to affect the choice that is selected even though marginal benefit and marginal cost are unaffected. </li></ul><ul><li>Letting Sunk Costs Matter . Allowing sunk costs, which have already been paid and do not affect marginal costs regardless of which option is chosen, to affect a decision. </li></ul><ul><li>Faulty discounting . Being too impatient when it comes to decisions that involve benefits that are received in the future or discounting future benefits inconsistently depending on when the delay in receipt of benefits occurs. </li></ul><ul><li>Overconfidence. Believing you will know what will happen in the future to a greater extent than is justified by available information. </li></ul><ul><li>Status Quo Bias . A tendency to make decisions by accepting the default option instead of comparing the marginal benefit to the marginal cost. </li></ul>Behavioral Economics recognizes that people respond to incentives, but their response is not always a rational one. 
  12. 13. <ul><li>Loss Aversion </li></ul><ul><li>“ The Power of Defaults” </li></ul><ul><li>Don’t Provide Too Many Choices </li></ul><ul><li>Timeframes Matter </li></ul><ul><li>When it comes to money, it’s “Here and Now” baby! </li></ul><ul><li>Mental Accounting </li></ul>
  13. 14. <ul><li>Size Matters </li></ul><ul><li>Lotteries are Fun! </li></ul><ul><li>Hassle is Bad </li></ul><ul><li>Appeal to one’s identity </li></ul><ul><ul><li>“ future”, “success”, providing for the children </li></ul></ul><ul><li>Peer Influence Works </li></ul><ul><li>“ What have you done for me today?” </li></ul>
  14. 15. <ul><li>“ I can’t lose what I never had!” (Perceived loss associated with giving up something is greater than perceived benefit of obtaining it) </li></ul><ul><ul><li>Examples include: </li></ul></ul><ul><ul><ul><li>“ Heads you win $x, tails you lose $100” </li></ul></ul></ul><ul><ul><ul><li>the inertia of “choice” (i.e., logoed mugs) </li></ul></ul></ul><ul><li>How can you use “loss aversion” to your benefit? </li></ul>
  15. 16. <ul><li>Decision-makers have an overwhelming tendency to adopt defaults, to stick with the status quo </li></ul><ul><ul><li>Even when the decision is important and the stakes are large </li></ul></ul><ul><ul><li>Even when the decision-maker is told that the default is not optimal </li></ul></ul><ul><ul><li>Examples: </li></ul></ul><ul><ul><ul><li>insurance deductibles </li></ul></ul></ul><ul><ul><ul><li>organ donation </li></ul></ul></ul><ul><ul><ul><li>Operation Fuel: donate $1 </li></ul></ul></ul><ul><li>How can you use “defaults” to your benefit? </li></ul>
  16. 17. <ul><li>“ If you give me too many choices, you’ve increased the likelihood I won’t make a decision!? </li></ul><ul><ul><li>Complexity delays choice, increasing the fraction of consumers who adopt default options (O’Donoghue and Rabin, 2004). </li></ul></ul><ul><ul><li>Complexity biases choice, since people tend to avoid complex options (Shafir and Tversky, 1994; Iyengar and Kamenica, 2006). </li></ul></ul><ul><ul><li>1/N rule – Add a second fund to your 401 (k) plan and many investors divide portfolio 50-50; add a third fund and 1/3 placed in each. </li></ul></ul><ul><li>How can you use “choices” to your benefit? </li></ul>
  17. 18. <ul><li>Incentives mean more when they are immediate; “long-term” has far less urgency </li></ul><ul><ul><li>Future value of money? </li></ul></ul><ul><ul><li>Payments for completion, or specific achievements along the way? </li></ul></ul><ul><ul><li>“ Rent to Own” Centers </li></ul></ul><ul><ul><li>Education is key to helping people understand this </li></ul></ul><ul><li>How can you use “timeframes” to your benefit? </li></ul>
  18. 19. <ul><li>People display inconsistent behavior when choosing for today or for tomorrow </li></ul><ul><li>Many choices involve benefits and costs that are received at different times </li></ul><ul><li>People tend to be impatient in the short-run. Causes irrational (inconsistent) choices. </li></ul><ul><li>Example: both choices involve delaying the receipt of $1 by a week. </li></ul>
  19. 20. <ul><li>People overvalue cash in hand and undervalue future dollars </li></ul><ul><ul><li>Makes them less likely to save for future uses </li></ul></ul><ul><li>Consequences (examples) include: </li></ul><ul><ul><li>RALs </li></ul></ul><ul><ul><li>Pay Day lending and Pawn Shops </li></ul></ul><ul><ul><li>Minimum payments on credit cards </li></ul></ul><ul><ul><li>Low savings rates among Americans </li></ul></ul><ul><li>How can you address this mentality? </li></ul>
  20. 21. <ul><li>People put money into different categories and have varying tendencies to save or spend from these “mental accounts” </li></ul><ul><ul><li>“ money in jars” </li></ul></ul><ul><ul><li>Make mental accounts real accounts! </li></ul></ul><ul><li>How can you use “mental accounting” to your benefit? </li></ul>
  21. 23. <ul><li>Increased choice makes us less able to choose. </li></ul><ul><li>Our habits affect our habits. </li></ul><ul><li>We don’t actually know the value of the things we buy. </li></ul><ul><li>People cannot always figure out what is in their best interest. </li></ul><ul><li>We’re swayed by things that do not matter. </li></ul><ul><li>We tend to throw good money after bad. </li></ul>
  22. 24. <ul><li>Re-design financial education offerings? </li></ul><ul><li>Change the way your market your programs </li></ul><ul><li>Change how your staff speaks about financial issues to your participants </li></ul><ul><li>Clarifies what is rational and irrational decision making </li></ul><ul><li>Help participants develop better understanding of opportunity costs, time discounting, and other economic concepts </li></ul>
  23. 25. <ul><li>Provides a richer, more realistic understanding of decision making in practice </li></ul><ul><li>Can lead to better policies </li></ul><ul><ul><li>Enrollments, renewals, advancement, etc. </li></ul></ul><ul><ul><li>(Pension Reform Bill) </li></ul></ul><ul><li>Help participants avoid making serious mistakes down the road (e.g., Don’t invest in employer 401 plans) </li></ul><ul><li>Nudge people along to make the best choices </li></ul>
  24. 26. <ul><li>About the populations you work with? </li></ul><ul><li>About their preferences? </li></ul><ul><li>About how they respond to marketing messages? </li></ul><ul><li>About why they engage (or don’t) with your organization? </li></ul><ul><li>What else don’t you know about them? </li></ul>
  25. 27. <ul><li>Language </li></ul><ul><li>Program design (inherent assumptions) </li></ul><ul><li>Client attitudes, beliefs, behaviors </li></ul><ul><li>Staff attitudes, beliefs, behaviors </li></ul><ul><li>Service delivery </li></ul><ul><li>Others? </li></ul>
  26. 28. <ul><li>Use jargon many do not understand </li></ul><ul><li>Use inappropriate reading level </li></ul><ul><li>Culturally inappropriate or incorrect </li></ul><ul><li>It looks Cheap! </li></ul><ul><li>Often lacks a [clear] value proposition </li></ul><ul><li>Reflects poor or no understanding of customer preferences </li></ul><ul><ul><li>What THEY consider “valuable” </li></ul></ul><ul><li>Confuses “features” v. “benefits” </li></ul><ul><ul><li>“ case management does not sell!” </li></ul></ul>
  27. 29. <ul><li>Let’s acknowledge the obvious: </li></ul><ul><ul><li>Financial education is not a silver bullet! </li></ul></ul><ul><ul><li>Behavior is not dealt with effectively – or just ignored – by many financial education programs </li></ul></ul><ul><ul><li>People do not like to talk about their money! </li></ul></ul><ul><li>And the not so obvious . . . </li></ul><ul><ul><li>Financial education programs often build-in faulty program designs </li></ul></ul><ul><ul><li>It really does matter who is teaching the course! </li></ul></ul>
  28. 30. <ul><li>Choice architecture is important! </li></ul><ul><li>Nudging people along is OK! </li></ul><ul><ul><li>Conflict between manipulation and social gain? </li></ul></ul><ul><li>Information (education) by itself is not enough to get people to change behaviors! </li></ul><ul><ul><li>Need for early-on help, active coaching, and peer support </li></ul></ul><ul><li>Create peer groups for mutual support and building a new identity </li></ul>
  29. 31. <ul><li>Behavioral economics provides an opportunity to re-think how services are provided </li></ul><ul><ul><li>Curriculum development </li></ul></ul><ul><ul><li>Brochures and marketing collateral </li></ul></ul><ul><ul><li>How to “engage” clients </li></ul></ul><ul><ul><li>programs that really work . . . like we hope they will! </li></ul></ul><ul><li>When working with low-income populations, behavioral economics can be a key factor for understanding financial decision-making </li></ul><ul><li>Pay attention to the client’s emotional and behavioral undercurrents </li></ul>

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