ECON 4013
Behavioral Economics
VI- Health and Well-being (P1)
Dr. Mohamed El-Komi
Plan
• Self Control Exercise and Discussion
• Definition of Self Control problems
• Temptation
• Readings:
– Behavioral Finance and Wealth Management: Ch.14, p. 150-162
– Nudge book
– Assigned papers
Self Control Exercise
• $50 today vs $100 6 months from today
– 50% today, 50% 6 months (really? 200%!)
• $50 one year vs $100 one year plus 6 months
– 14% one year, 86% one year + 6 months
• Same decision (huge rate of return)
– Present-bias, hyperbolic discounting, …
What is Self Control?
• Tradeoffs between money/exercise/food now and money/exercise/food later are not what we expect them to be.
• Individuals over-value money/food/relaxing now, relative to other possibilities
– Leads to under-investment, under-savings, obesity and many other (economic) problems
Exponential Discounting
Empirical
• People over-value sooner payoffs and undervalue later payoffs when they occur sooner
• Alternative forms of discounting (nonexponential)
– Hyperbolic, present-valued, …
• Leads to choice reversals and self-control problems (when 1 year out, choose to wait 6 months, but when it
approaches, choose to take the money now)
• Other domains (health, …)
Hyperbolic vs. Exponential Discounting
Another Implication of Exponential Discounting
• Life-Cycle Savings Model
– Plan for increasing then declining levels of income
– Plan savings / spending patterns to keep spending pattern constant (why?: Habit formation)
– Dis-save when young, save when middle-aged, dis-save when old
• In practice, people don’t save/exercise enough
– Note: independent of how they invest their savings/time
Temptation
• Easier to recognize than to define: US Supreme Court Justice Potter Stewart’s “I know it when I see it”
• Different states of arousal, vary over t: hot and cold (e.g. smelling barbecue, while hungry vs. planning your week’s
meals on Saturday night)
• Something is “tempting”: consume more of it when hot than when cold
• “Hot-cold empathy gap”: When cold à do not appreciate how much our desires and our behavior will be altered
when we are “under the influence” of arousal. (George Loewenstein, 1996)
Thaler and Shefrin (1988)
• Behavioral Life-Cycle Hypothesis
– Model including self-control, mental accounting, framing
• Assume wealth divided into income, assets and future income
– Spend more from current income, next from assets and finally from future income
• Two-body problem
– Planner and Do-er
Two Bodies
• Planner cares about lifetime consumption (happiness), Doer cares only about today’s consumption (happiness).
• Parameter of willpower (cost to increase) which determines how the planner and doer decide how much to consume
in a given period
• Planner imposes constraints on current consumption (e.g. putting funds into pension plan that doesn’t allow
withdrawls) (See Laibson later)
Equilibrium
• Planner divides wealth (food, health,…etc.) into categories
• Allows doer to spend freely out of current income, exerts some willpower over assets, and exerts more willpower
over future income
• Model consistent with a broad variety of observations (but somewhat ad-hoc)
Laibson (1997)
• Model of hyperbolic discounting (vs exponential discounting)
• Can invest in liquid or non-liquid asset (can borrow against non-liquid asset at some cost)
• Labor income, consumption each period
• In equilibrium, choose some non-liquid asset to constrain future self to consume less
Both Models Predict…
• Different marginal rate of consumption from different types of money
• Souleles (1999) tests life-cycle hypothesis with tax refunds
• 80% of refunds mailed in March, April and May
• Looks at consumer expenditures survey, 1980-1991, and expenditures during those months other months
Results
• For each tax dollar received, consumption that month rises by 18 cents.
• Mostly due to increased spending on durables
• Not due to liquidity-constrained households
• 35%-60% of the refund was spent within the 3 months after it was received.
• Not life-cycle spending
• PP implications…..
Graham and Isaac (2002)
• Survey evidence of Thaler and Shefrin
• Faculty members at American University
– 9 month or 12 month salary (12 months delays money with no additional benefit)
– 109 faculty members responded to an online survey
Results
• 76% take 12 monthly payments
• Only 5 % have ever considered the losses this choice entailed
– In contrast, those who choose 12 months, 82% said they considered lost earnings
• 12 month people said “ease of planning” or “same paycheck each month”
• How much would you have to be paid to switch?
– 12 month average $544
Self Control and Impulsivity
• Related to (but not identical with) impulsivity
– 4 year old children and marshmallows (Mischal et al.)
– 18 years old (Shoda, Mischel, & Peake, 1990)
– 1/3 most impulsive significantly lower SAT than 1/3 least impulsive (210 points total); 2ce as good a predictor as IQ
• Poor impulse control is also a better predictor of later delinquency than is IQ (Block, 1995).
Temptation Control
• Enable the (far-sighted) Planner over the (myopic) Doer (e.g. Clocky and
Tocky)
• Use a tough controller (loss aversion)
• John Romalis and Dean Karlan’s weight control experiments:
– Putting on weight while in graduate school
– Each lose 30 Ib over 9 months, OR, pay $10,000
– BUT, keep weight off: call for weigh-in on one day notice. If over target weight, pay a fine immediately (four years,
only once was either one over target)
– Now, Stickk.com (pay money in, goes to charity if not sticking to target)