De Econometrist neemt een statistische kijk op de wereld.
In his dystopian novel ‘1984’, George Orwell introduces a society which is controlled by the government. All the news is fabricated and everything is monitored by the so-called “Thought Police”. The book discusses the consequences of an authoritarian government and how the manipulation of facts influences politics. For instance, the main job of the protagonist, Winston Smith, is to alter the news shown to society when it did not coincide with the way things really happened. Luckily, in our era things are way less extreme (at least in the Netherlands), but similarities can be drawn to the way things were in the Sovjet Union under the authority of Joseph Stalin. Nevertheless, how free are we really to choose what we want, and to what extent can the government influence what we want to do?
One of the prominent examples of how your choices can be influenced by your environment is menu dependence. Take for instance the last time you went to the cinema and wanted a snack during the movie. The different options could be similar to the ones displayed below.
For simplicity, let us assume that two medium popcorns are larger than one large popcorn and four small popcorns are larger than a large popcorn. So, the final option is strictly redundant in the sense that a rational person would always choose to buy two medium popcorns over a large one. You might wonder then: why is the large popcorn actually added to the menu, as rational people will not buy this. The reason is quite interesting and introduces the so-called ‘decoy effect’. When an option is added to a menu that is dominated by the ‘target option’ (in our case the medium popcorn), the ratio of the preferences between the target and the ‘competitor’ (in our case the small popcorn) will actually change. This can be seen when we compare the ratio of the menu with 3 options to ratio when we look at a menu in which we only display the small and medium popcorn. This is because by adding the ‘large’ option to the menu, the medium popcorn will look like a better deal. So, without you being aware, your choices are influenced by how certain things are framed.
Framing takes a prominent role in more situations than we might think. For instance, suppose you have to choose between two ways you can pay each time for using your credit card. One option is to pay a fixed amount each month and get a discount every time you use your credit card. The other option is to obtain a certain sum of money, but a fee is deducted. Assuming that both options yield the same monetary amount obtained, standard microeconomic theory suggests that there is no difference between the two options. However, insights from prospect theory suggest that the second option is less attractive, as we attach higher value to losses than to equivalent gains. This is also the reason why in 1985 a law introduced by the Californian state was very eagerly accepted by credit card companies. This law prohibited these companies from adding surcharges to their customers. As a consequence, they were able to frame the payments in terms of gains, which boosts sales as this is more attractive to customers. More on how framing influences the choice people make can be found in this article by Stan Koobs.
Building upon rational choice theory, one thing to note is that in practice it rarely holds. People consistently make irrational decisions which causes society to never reach the optimum discussed in standard microeconomics textbooks.
Interventions that steer the market outcome towards the social optimum are called ‘nudges’. Nudges assist people to let them make better decisions whilst still allowing them the freedom to choose. One example of a nudge could be to put more healthy options in a supermarket at eye-height, so customers are more drawn to these options. Or take the issue of organ donation in the Netherlands. The default option used to be to not be registered to donate any of your organs. However, after 1 july 2020, the default became to be registered as an active donor (that is, if you don’t actively submit your preferences). Because people have a tendency to like the status-quo, this small change to organ donation registration could have big consequences. Being (often) cost-free and not having a large effect on already rational agents, these kinds of implementations are very useful and applicable in practice.
One difficult question is then: to what extent is the government allowed to implement policies that ensure that people make more rational choices? Nudging is a form of libertarian paternalism: steering people’s choices whilst still giving them choice freedom. Opponents of this kind of policy implementation might refer to images of a ‘Big Brother Society’, where the government controls everything we see and think. On the other hand, more ‘extreme’ minded people might argue that there is ground for a more paternalistic view in which the government steers our choices that yield a more flourishing society. For instance, take the issue of smoking. It is well known by now that smoking too much is very bad for your health: the long term consequences of a pack of cigarettes a day should outweigh the short term pleasure obtained from this. However, suppose that someone disagrees and keeps on smoking a pack a day. This is an example of a consistent irrational choice. Should we force these kinds of people to change their behaviour this much, because we argue that smoking (or take for example the usage of drugs, unhealthy dieting or choices to save too little) is inherently bad? If you do not know the answers to these kinds of questions, do not worry. As long as you are on the lookout for good popcorn deals in the cinema you will be fine!
Erik Angner: A Course in Behavioral Economics (2nd edition, 2016)
Daniel Kahneman: Thinking, Fast and Slow (2011)
This article is written by Simon Elgersma