Behavioral Economics & Public Policy Tools

• The incorporation of psychology into economics, often framed as a question about foundational assumptions, can improve empirical predictions and policy decisions.
• Behavioral economics contributes by offering new policy tools, improving predictions about existing policies' effects, and generating new welfare implications.
• Uses applications to retirement savings, labor supply, and neighborhood choice to illustrate these contributions
• Authors of note in the field of behavioral economics include Simon, Kahneman and Tversky, and Thaler.
• Classical economists, including Adam Smith discussed ideas that are now formalized in behavioural economics

Behavioral Economics and Public Policy Tools:

• New tools change behaviors like savings rates.
• Provides new counterfactuals to estimate policies' effects, like income taxation.
• Optimal policy prescriptions characterized non-paternalistically using methods analogous to neoclassical models, emerge from such models.
• Behavioral nudges are justified by model uncertainty, which doesn't justify using the neoclassical model.
• Incorporating behavioral features that help answer core economic questions is more productive than treating behavioral economics as a separate subfield.
• Insights from psychology offer innovative approaches, such as altering default options or framing incentives as losses instead of gains, thereby broadening the spectrum of achievable policy outcomes.
• Expansion parallels the shift from linear commodity taxes (Ramsey 1927) to non-linear tax policies (Mirrlees 1971).
• Incorporating these can provide enhanced insights into incentives like retirement savings subsidies or income tax policies.
• Help econometricians in developing new counterfactuals that lead to identifying policy impacts
• Such as inattention or myopia, can lead to discrepancies between welfare as perceived by a policy maker.
• Behavioral models can offer insights into welfare through their impact on experienced utilities
• Labels to describe manipulated conditions by policy makers are "nudges n" following Thaler and Sunstein (2008) and a set of other conditions (d) are conditions that cannot be manipulated.
• It is useful to separate the effects of conditions into two groups: nudge and manipulated policy

Applications of Behavioral Economics

• The applications focus on personal choices on saving, working, and choosing where to live
• Aims at showing how, by integrating insights, one can attain superior answers to the these questions
• New policy tools can lead to increased savings that may be unattainable through neoclassical means

Earned Income Tax Credit (EITC)

• Largest means-tested cash transfer program in the United States influences households' labor supply.
• Subsidies encourage low-wage work.
• Individuals in areas with more EITC recipients are more informed and responsive.
• Knowledge differences yield counterfactuals that pinpoint the EITC’s impacts on labor supply.
• Results indicate the EITC's effectiveness in boosting earnings for low-wage workers.
• Differences in knowledge regarding the program has an impact on existing incentives.

Welfare Design and Optimal Models

• Policymakers consider housing voucher subsidies to alter choices on neighborhoods for low-income families.
• Some neighborhoods have superior outcomes for children independent of housing costs.
• Both neoclassical and behavioral models explain why families not move to certain neighborhoods, but generate differing policy prescriptions.
• Encouraging families to relocate to better areas by providing housing vouchers or assistance for the search of apartments
• The best approach are based on three non-paternalistic methods: Measuring experienced utility via self-reported happiness, using revealed preference where choices maximize experienced utilities, & creating a structural model to detail differences between decision and experienced utilities
• These methods offer precise prescriptions and better methods, ultimately increasing social welfare among individuals who suffer from biases.
• Economists use the neoclassical model as the default due to uncertainty, but a more principled approach involves explicitly accounting for it when devising the optimal policy
• Optimal policy might involve behavioral "nudges" (defaults, framing) to change behavior and improve welfare where biases exists.
• Subsidies should be means tested and be paid in lump sums

Further Considerations for BE incorporation

• Models should be treated like all standard modeling decisions like firms taking prices as they are
• Simpler models in certain applications and the relevance depends on the specific application
• Deviations from rationality vary widely across settings and by the impact of various effects.
• Relevant when answering question of interest because behavioral models are more productive to neoclassical models
• Thaler and Sunstein (2008), Congdon, Kling and Mullainathan (2011), Keller-Allen and Li (2013), and Madrian (2014) give new tools and expectations developed from behavioral economics
• Bernheim (2009) and Mullainathan, Schwartzstein and Congdon (2012) discussed behavioral models and standards.
• Lessons from psychology translated to economics and documented by empirical evidence.
• Conlisk (1996), Rabin (1998), and DellaVigna (2009) provided overviews