explains why Nat simply wrote: “Economists discover marketing” in a radar backchannel email rather than taking the time to write an entry about The Marketplace of Perceptions, the Harvard Magazine article on behavioral economics he was referencing :-) There’s a section in the article about “intertemporal choice”, exemplified by “Wimpy, Popeye’s portly friend with a voracious appetite but small exchequer, who made famous the line, ‘I’ll gladly pay you Tuesday for a hamburger today.'”
This is only one of the many subjects covered in this fascinating article about how the way issues are framed affects people’s choices far more than classical economics would expect.
One paragraph particularly caught my eye, because it echoes the insight from Dan Bricklin’s Cornucopia of the Commons that I frequently reference in my talks. Dan argues that part of the genius of Napster was that it made sharing the default, rather than a voluntary contribution.
The article applies this idea to 401(k) plans: “People want to be prudent, they just don’t want to do it right now,” [David] Laibson says. “You’ve got to compel action. Or enroll people automatically.” When he was U.S. Treasury Secretary, Lawrence Summers applied this insight. “We pushed very hard for companies to choose opt-out [automatic enrollment] 401(k)s rather than opt-in [self-enrollment] 401(k)s,” he says. “In classical economics, it doesn’t matter. But large amounts of empirical evidence show that defaults do matter, that people are inertial, and whatever the baseline settings are, they tend to persist.”
It was this idea of the importance of defaults that led me to frame the idea of “the architecture of participation.” In discussions with Web 2.0 startups, I tend to hammer on this point: what are you doing to make participation automatic, and sharing as widely as possible the default behavior? (This is one reason Flickr became so successful. While Web 1.0 photo sharing services made sharing with your friends and family as the default, Flickr made “world” the default setting.)
Some other tidbits from the article:
Two non-economists have won Nobel Prizes in economics. As early as the 1940s, Herbert Simon of Carnegie Mellon University put forward the concept of “bounded rationality,” arguing that rational thought alone did not explain human decision-making. Traditional economists disliked or ignored Simon’s research, and when he won the Nobel in 1978, many in the field were very unhappy about it.
Then, in 1979, psychologists Daniel Kahneman, LL.D. ’04, of Princeton and Amos Tversky of Stanford published “Prospect Theory: An Analysis of Decision under Risk,” a breakthrough paper on how people handle uncertain rewards and risks. In the ensuing decades, it became one of the most widely cited papers in economics. The authors argued that the ways in which alternatives are framed—not simply their relative value—heavily influence the decisions people make. This was a seminal paper in behavioral economics; its rigorous equations pierced a core assumption of the standard model—that the actual value of alternatives was all that mattered, not the mode of their presentation (“framing”).
Here’s a bit more on intertemporal framing:
A national chain of hamburger restaurants takes its name from Wimpy, Popeye’s portly friend with a voracious appetite but small exchequer, who made famous the line, “I’ll gladly pay you Tuesday for a hamburger today.” Wimpy nicely exemplifies the problems of “intertemporal choice” that intrigue behavioral economists like David Laibson. “There’s a fundamental tension, in humans and other animals, between seizing available rewards in the present, and being patient for rewards in the future,” he says. “It’s radically important. People very robustly want instant gratification right now, and want to be patient in the future. If you ask people, ‘Which do you want right now, fruit or chocolate?’ they say, ‘Chocolate!’ But if you ask, ‘Which one a week from now?’ they will say, ‘Fruit.’ Now we want chocolate, cigarettes, and a trashy movie. In the future, we want to eat fruit, to quit smoking, and to watch Bergman films.”
Laibson can sketch a formal model that describes this dynamic. Consider a project like starting an exercise program, which entails, say, an immediate cost of six units of value, but will produce a delayed benefit of eight units. That’s a net gain of two units, “but it ignores the human tendency to devalue the future,” Laibson says. If future events have perhaps half the value of present ones, then the eight units become only four, and starting an exercise program today means a net loss of two units (six minus four). So we don’t want to start exercising today. On the other hand, starting tomorrow devalues both the cost and the benefit by half (to three and four units, respectively), resulting in a net gain of one unit from exercising. Hence, everyone is enthusiastic about going to the gym tomorrow.
The part that explains the role of framing with concrete examples (Nat’s point about “economists discover marketing”) was particularly interesting:
“We tend to think people are driven by purposeful choices,” [Sendhil Mullainathan] explains. “We think big things drive big behaviors: if people don’t go to school, we think they don’t like school. Instead, most behaviors are driven by the moment. They aren’t purposeful, thought-out choices. That’s an illusion we have about others. Policymakers think that if they get the abstractions right, that will drive behavior in the desired direction. But the world happens in real time. We can talk abstractions of risk and return, but when the person is physically checking off the box on that investment form, all the things going on at that moment will disproportionately influence the decision they make. That’s the temptation element—in real time, the moment can be very tempting. The main thing is to define what is in your mind at the moment of choice. Suppose a company wants to sell more soap. Traditional economists would advise things like making a soap that people like more, or charging less for a bar of soap. A behavioral economist might suggest convincing supermarkets to display your soap at eye level—people will see your brand first and grab it.”
…Mullainathan worked with a bank in South Africa that wanted to make more loans. A neoclassical economist would have offered simple counsel: lower the interest rate, and people will borrow more. Instead, the bank chose to investigate some contextual factors in the process of making its offer. It mailed letters to 70,000 previous borrowers saying, “Congratulations! You’re eligible for a special interest rate on a new loan.” But the interest rate was randomized on the letters: some got a low rate, others a high one. “It was done like a randomized clinical trial of a drug,” Mullainathan explains.
The bank also randomized several aspects of the letter. In one corner there was a photo—varied by gender and race—of a bank employee. Different types of tables, some simple, others complex, showed examples of loans. Some letters offered a chance to win a cell phone in a lottery if the customer came in to inquire about a loan. Some had deadlines. Randomizing these elements allowed Mullainathan to evaluate the effect of psychological factors as opposed to the things that economists care about—i.e., interest rates—and to quantify their effect on response in basis points.
“What we found stunned me,” he says. “We found that any one of these things had an effect equal to one to five percentage points of interest! A woman’s photo instead of a man’s increased demand among men by as much as dropping the interest rate five points! These things are not small. And this is very much an economic problem. We are talking about big loans here; customers would end up with monthly loan payments of around 10 percent of their annual income. You’d think that if you really needed the money enough to pay this interest rate, you’re not going to be affected by a photo. The photo, cell phone lottery, simple or complicated table, and deadline all had effects on loan applications comparable to interest. Interest rate may not even be the third most important factor. As an economist, even when you think psychology is important, you don’t think it’s this important. And changing interest rates is expensive, but these psychological elements cost nothing.”
and
When making choices in the marketplace, “People are not responding to the actual objects they are choosing between,” says Eric Wanner of the Russell Sage Foundation. “There is no direct relation of stimulus and response. Neoclassical economics posits a direct relationship between the object and the choice made. But in behavioral economics, the choice depends on how the decision-maker describes the objects to himself. Any psychologist knows this, but it is revolutionary when imported into economics.