Economics after behavioral attack
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Behavioral issues
in energy and the environment
Economics 331b
Spring 2011
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Agenda as of 2/16
Today: Behavioral economics
Friday: Lint will lead review session
Monday: Climate science
Wednesday: Climate science and IAM
Thursday: review material in sections
Friday: midterm in class
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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.)
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A central behavioral puzzle:
First-cost v. deferred cost
The energy efficiency puzzle:
Consider the life-cycle cost (LCC) of an automobile:
LCC = Purchase price + ∑(1+r)-t FutureCostt
= First cost + Deferred cost
Finding: Deferred cost is generally discounted by 50% or
more.
What is going on here?
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The challenge to mainstream economics
Here are some issues of decision 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)
Institutions are appropriately designed so that people acting
rationally will make good decisions (good institutions).
People have self-interested and stable preferences over
consumption of goods, services, and capital (non-weird
preferences)
Behavioral economics challenges all of these.
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1. Informational incompetence
Classical view: People have good information and/or process
information efficiently
Behavioral view: 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.
• Most smokers believe they are less at risk of developing smokingrelated diseases than others who smoke.
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What did people do in buying a car relative to a survey?
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2. Decision incompetence
Classical view: People act to optimize their preferences relative to
information and resources
Behavioral view: People make all kinds of trivial and tragic mistakes in
daily life
Examples:
• Bet on red because red “is due to come up soon.”
• 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?
• MPG illusion
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Defaults matter for organ transplants
Eric J. Johnson and Daniel Goldstein, “Do Defaults Save Lives?” Science,
Nov 2003.
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3. Bad incentives and institutions
Classical: Institutions are structured so that rational actors will
produce efficient decisions
Behavioral: All kinds of principal-agent problems get in the way
Examples:
– Energy pricing: Yale pays the electricity bill, so the price of
higher energy use to students and faculty is…. ZERO.
– Tax distortions
– Political: what are the incentives for political leaders to set
MSB=MSC?
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Zero marginal cost energy
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Effect of energy incentives on energy in rent v. own
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International Energy Agency, Ming the Gap, 2007
4. Weird* preferences
Classical: People have self-interested preferences over consumption of
goods, services, and capital (standard preferences)
Behavioral: People are altruistic, care about fairness, will contribute to
the public good, have spite.
Examples:
• Prisoners’ dilemma: In fact, people are much more likely to
cooperate than the PD game would predict. (Good news for
public goods)
• Spite: But some people will fight to the death and bring
everyone else down with them (Hitler)
In sense of not conforming to classical economics.
Not purely concerned with optimizing a stable, time-consistent,
purely self-interested, complete set of preferences over all market and
non-market goods and services for all periods in the future.
Also, altruistic, kinky, funky, wild, erratic, spaced-out, random,
slapdash.
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Weird preferences (cont.)
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:
– Hyperbolic preferences: overdiscount future pains and benefits
– 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 three, 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”).
• Bad institutions need fixing (meter Yale rooms?)
For last one, deep philosophical and political issue about whether
should respect individual preferences:
• 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.
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First-cost v. future cost
The energy efficiency puzzle:
Consider the life-cycle cost (LCC) 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]
What is going on here?
•
•
•
•
•
•
Incomplete information about MPG or fuel prices?
Risk or loss aversion?
High discount rates and hyperbolic discounting?
Principal-agent conflicts?
Computational incompetence (bounded rationality)?
Limited managerial time?
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Defaults matter for organ transplants
Eric J. Johnson and Daniel Goldstein, “Do Defaults Save Lives?” Science,
Nov 2003.
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The Zillion Dollar Question
Are all these minor “anomalies” … or are they central to
economic behavior?
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