Agenda as of 2/17
Today: A final word on behavioral economics
Begin Climate Science
Friday: No class
Monday 2/22: Problem set 2 due
Climate science and begin integrated assessment models
Wednesday: Climate science and IAM
Friday: review
Monday, 3/1: hour test in class
1
Behavioral issues
in energy and the environment
Economics 331b
Spring 2010
2
Background
Major grounds for government intervention in energy and
environmental markets:
1. Market failures (uninternalized externalities such as
CO2 emissions, oil premium, …)
2. Behavioral failures (informational, decisional, etc.)
3
The challenge to mainstream economics
Here are some issues of preference theory from standard
economics that are challenged (from least to most
damaging):
1.
2.
3.
4.
People have good information and/or process information
efficiently (data competence)
People act to optimize their preferences relative to information
and resources (decision competence)
People have self-interested preferences over consumption of
goods, services, and capital (non-weird preferences)
People have well defined or stable preferences over goods and
time (coherent/stable preferences)
Behavioral economics challenges all of these.
Important note: Behavioral failures are different from
market failures!
4
Economics after behavioral attack
5
Informational incompetence
Classical: People have good information and/or process information
efficiently
Behavioral: People have all kinds of biases in structuring information
(law of small numbers, overconfidence, anchoring, hindness bias)
Examples of overconfidence effect:
• Second-year MBA students overestimated the number of job offers
they would receive and their starting salary.
• Students overestimated the scores they would achieve on exams.
• Almost all newlyweds in a US study expected their marriage to
last a lifetime, even while aware of the divorce statistics.
• Professional financial analysts consistently overestimated
corporate earnings.
• Most smokers believe they are less at risk of developing smokingrelated diseases than others who smoke.
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Decision incompetence
Classical: People act to optimize their preferences relative to
information and resources
Behavioral: People make all kinds of trivial and tragic mistakes in
daily life
Examples:
• 4 million unwanted pregnancies a year
• 37,000 traffic fatalities in 2008
• Addictions (smoking, alcohol, …)
• Default option matters in pension decisions, organ transplants
• Refusal to lower the asking price on house because it is below the
price you paid for your house?
7
Defaults matter for organ transplants
Eric J. Johnson and Daniel Goldstein, “Do Defaults Save Lives?” Science,
Nov 2003.
8
Weird (i.e., non-classical-economics) preferences
Classical: People have self-interested preferences over consumption of
goods, services, and capital (non-weird preferences)
Behavioral: People are altruistic, care about fairness, will contribute to
the public good, have spite.
Examples:
• The ultimatum game: I start with $100. Then I keep X for
myself and offer you $100-X take-it-or-leave it. Both parties
agree for anyone to get anything.
- Economics predicts solution is (100-ε, ε).
- In fact, we see most often (50, 50). Moreover, (90,10) is often
rejected by second party.
• Cooperation, fights, wars, strikes, …
9
Unstable/incoherent preferences
Classical: People have well-defined and stable preferences over goods
and time (stable preferences)
Behavioral: People have status-quo bias, reference levels, adaption,
loss aversion, hyperbolic discounting, uncontrollable passion or
rage
Examples:
– The mug-ring experiment: I pass out 10 Yale mug and 10
Bulldog rings at random. Each costs $10. Then at the end of the
class, I organize a swap. 90 percent choose what they got at
random. This illustrates the endowment effect or status quo
bias.
– Difference between willingness to pay and willingness to
accept in contingent valuation studies (for say species
extinction)
– More important is adaptation to current situation: happiness
paradox, lottery winners, quadriplegics, “rat race” or
“treadmill” syndrome
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What are policy responses
For first two, not deep philosophical issues and requires education,
better information, nudges:
• Data incompetence: provide better data or simplify calculations
(labeling, $ labeling on energy using appliances)
• Decision incompetence: “Nudge” to more sensible decisions with
different default options (“soft parentalism”).
For last two, deep philosophical and political issue about whether
should respect individual preferences:
• “Weird” preferences: Shouldn’t we respect them?
• Incoherent preferences: Should governments override them? Treat
people like children?
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What should we think about?
• The gasoline paradox: People pay $0.37 for $1 of PV of
gasoline savings?
• The organ transplant opt-in/opt-out paradox.
12
Defaults matter for organ transplants
Eric J. Johnson and Daniel Goldstein, “Do Defaults Save Lives?” Science,
Nov 2003.
13
First-cost v. future cost
The energy efficiency puzzle:
Consider the life-cycle cost of an automobile:
LCC = purchase price + present value running costs
= purchase price + ∑(1+r)-t FutureCostt
Basic result is that the breakeven discount rate is 20+% p.y
[E.g., Allcott and Wozny ≈ 60 % per year; Hausman ≈ 25 % per year]
What is going on here?
•
•
•
•
•
•
Incomplete information about MPG or fuel prices
Risk or loss aversion
High discount rates
Principal-agent conflicts
Computational incompetence (bounded rationality)
Limited managerial time
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Source: David Greene, “Uncertainty, Loss Aversion and Markets for Energy Efficiency”
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The Zillion Dollar Question
Are all these “anomalies” or are they central to economic
behavior?
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