Behavioral Economics 101: Decision Making in the Context of Povery

Psychology101:Financial Decision Making in the Context of PovertyCrystal C. HallUniversity of WashingtonEvans School of Public AffairsJanuary 25, 2011v1NYTimes 4/1/07Can Poor People be Taught to Save?

Image: flickr.com user Compound Eye2NYTimes 4/1/07Can Poor People be Taught to Save?I had expected people would talk about the cost of not having a bank account or having a bad credit historyI thought theyd talk about financial inconvenience, but they instead talked about the stress. In many cases, people didnt save not because they actually couldnt but because they believed they couldnt.

Image: flickr.com user Compound Eye3NYTimes 4/1/07Can Poor People be Taught to Save?Part of that psychological barrier was social pressure to not save; the minute people got a little surplus, friends and family would start asking for loans. There were other obstacles too. People in both communities feared losing welfare benefits if they accumulated cash.

Image: flickr.com user Compound Eye4NYTimes 4/1/07Can Poor People be Taught to Save?Part of that psychological barrier was social pressure to not save; the minute people got a little surplus, friends and family would start asking for loans. There were other obstacles too. People in both communities feared losing welfare benefits if they accumulated cash.

Image: flickr.com user Compound Eye5Decision Making in Poverty:A Behavioral ApproachTwo dominant views of behavior of LI(Bertrand, Mullainathan & Shafir, 2006)Rational agent viewCulture of poverty view

A behavioral perspective

6A Behavioral ApproachBenefits to this approachTheoreticalPractical

Behavioral puzzlesLack of bank accountsLow take up of public assistance

7Overall GoalsConsideration of viewpoint of the poorSocial environmentRelationships with institutions

Connecting findings to real-world contextDeveloping low-cost interventionsFacilitating channel factors

8Power of the situation!A key assumption about human psychologyEveryone is irrational.Assumptions about LI behaviorTraditional assumptionsDo NOT sufficiently account for LI behavior

Does not suggest thatThe theories are incorrectLI behavior operate under a different (or deficient!) psychology

Assumptions about behaviorTraditional assumptionsDo NOT sufficiently account for LI behavior

Does not suggest thatThe theories are incorrectLI behavior operate under a different (or deficient!) psychology

Instead: Subtle differences in what features of the context matter!An exampleImagine that you go buy a winter jacket that costs $10 ($60). The clerk informs you that a store twenty minutes away sells the same jacket for $5 less. Would you go to the other store to buy the jacket?An exampleImagine that you go buy a winter jacket that costs $10 ($60). The clerk informs you that a store twenty minutes away sells the same jacket for $5 less. Would you go to the other store to buy the jacket?Percent YesOverviewWhat is behavioral economics?

Key findings from BE and related fields

Examples in the real world

Lessons learnedWhat is behavioral economics?17What is Behavioral Economics?Blend of multiple fieldsEconomicsCognitive PsychologySocial Psychology

Judgment and decision making

Behavioral decision research

18What is Behavioral Economics?Typical assumptions of traditional economics not accurateRationalSelf-interestedConsistent

Difference between normative and descriptive theories of behavior

19What is Behavioral Economics?A key observation of BE:

Individuals are irrational but often extremely predictable!

It is the goal of behavioral economics to locate and describe these patterns of irrationality20Understanding human behaviorRational agent model (normative)Well-informedStable preferencesControlled and calculating

Behavioral model (descriptive)Mediocre judgmentMalleable preferencesImpulsive*but, behavior is often predictable!!(behavioral economics falls into second category, rational agent model is normative, but is NOT description) doesnt help with trying to understand observed patterns of behavior (that are very predictable!)

Contrast these two views.why is this interesting for asset building? 21Two views of povertyRational choice viewWell defined preferencesBehavior is adaptation to existing conditions

Pathology viewBehaviors specific to culture of povertyPsychological pathologies, inherent judgment problemsTwo views of povertyRational choice viewWell defined preferencesBehavior is adaptation to existing conditions

Pathology viewBehaviors specific to culture of povertyPsychological pathologies, inherent judgment problemsNeither does a great job of explaining behavior23Two views of povertyRational choice viewWell defined preferencesBehavior is adaptation to existing conditionsPathology viewBehaviors specific to culture of povertyPsychological pathologies, inherent judgment problemsA behavioral perspectiveAssumes LI susceptible to same types of biasesMust include consideration of social context

24Key insights from behavioral research25Do people think logically?System 1 versus System 2Intuition vs. Reasoning

Problems with monitoring and correction

A bat and a ball together cost $1.10. The bat costs a dollar more than the ball. How much does the ball cost?System 1 (intuition)FastAutomaticEffortlessAssociativeSlow-learningEmotional

System 2 (reasoning)SlowControlledEffortfulRule-basedFlexibleNeutral

Image: flickr.com user smilehamIntuition versus ReasoningMental shortcuts developed by System IHeuristics and biases

Bounded rationality!Mental Shortcuts in JudgmentLoss aversion/Framing

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Image: flickr.com user alancleaver_2000Mental Shortcuts in JudgmentLoss aversion/Framing

Anchoring

33Mental AccountingHow individual keep track of financial activity

Set of cognitive operations

Focus on three componentsPerception/experience of outcomesAssignment of monetary activity to accountsFrequency of choice evaluation and bracketingViolations of fungibility

34Other conceptsPower of defaultsOrgan donationNudge, recent book by Richard Thaler and Cass Sunstein

Johnson & Goldstein, 2003Other conceptsPower of defaultsOrgan donationNudge, recent book by Richard Thaler and Cass SunsteinCognitive primingPrinceton studentsFemale Asian graduate students in mathematics37Other conceptsPower of defaultsOrgan donationNudge, recent book by Richard Thaler and Cass SunsteinCognitive primingPrinceton studentsFemale Asian graduate students in mathematicsChannel factors matter!Tetanus shots

38So what about financial decision making in the context of poverty?BE in action!Purchase of lottery tickets

(Haisley, Mostafa & Loewenstein, 2008)Framing influences purchase of lottery ticketsMyopiaPriming of poverty

BE in action!Rent to own contracts (Zikmund-Fisher & Parker, 1998)

What actually explains demand?Risk aversionFinancial management tool

BE in action!Take up and use of savings products

Save more tomorrowSave every way

BE in action!Affirmation priming

Taking Information about EITC

47What should I keep in mind?48The inconsistency of humansChronic divergence between intentions and behaviorsInfluence of contextCurrent vs. future self

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Photo: flickr user CimmThe inconsistency of humansChronic divergence between intentions and behaviorsInfluence of contextCurrent vs. future self

But: inconsistency unpredictability!51A two part approachUnderstanding mechanisms/assumptions

Designing and testing interventions

The role of social context!Decisions stem not from the objective states of the world, but the individual mental representations created of those states!Areas for investigationIdentity and affirmationWhat role do stigma/stereotypes play?Better understand mechanisms behind financial choices and behaviorSigns of SESSocial class as cultureSocial normsInterpersonal interactionsMore on mental accountingBudgeting patternsFraming

What/where/when are critical moments?

Teach them to lower their fees and be courteous to people whether youre dressed nice or not. Dont make us feel invisible or beneath your grade.

Teach them to lower their fees and be courteous to people whether youre dressed nice or not. Dont make us feel invisible or beneath your grade.

Seattle Times, 9/23/2008A message to banks, from a Bank on Seattle clientQuestions and Comments!