Thursday, 2 July 2015

The principles of (behavioural) economics, and Gary Becker as a teacher

The annual Papers and Proceedings issue of the American Economic Review (gated) is always a treasure trove of interesting papers. This year was no exception, but two papers in particular caught my eye.

The first was "Principles of (Behavioral) Economics", by David Laibson (Harvard) and John List (University of Chicago). Laibson and List, along with Daron Acemoglu (MIT) have a new principles textbook that integrates behavioural economics throughout (I have just received a review copy of the text, but haven't had a chance to have a decent read of it yet). However, rather than outline an entire principles-course-worth of material, this article outlines six key principles that can be covered in one (or two) lectures. The principles are:

  1. People try to choose the best feasible option, but they sometimes don't succeed;
  2. People care (in part) about how their circumstances compare to reference points;
  3. People have self-control problems;
  4. Although we mostly care about our own material payoffs, we also care about the actions, intentions, and payoffs of others, even people outside our family;
  5. Sometimes market exchange makes psychological factors cease to matter, but many psychological factors matter even in markets; and
  6. In theory, limiting people's choices could partially protect them from their behavioral biases, but in practice, heavy-handed paternalism has a mixed track record and is often unpopular.
Laibson and List illustrate each concept with interesting examples. One of the key things they point out though, is that behavioural economics is not a replacement for traditional economic theory, it complements the traditional theory.

I was grateful for reading the paper, because it helped me to work out a puzzle that arose during the last University of Waikato Open Day. I gave the economics mini-lecture for Open Day, and as part of it I ran a short experiment designed to illustrate the gains from trade. In the experiment, I randomly give a small (free) gift to each of ten volunteers from the audience, then ask each of them to rate their gift on a scale from zero to ten. The total of the volunteers' ratings give a measure of welfare gain from the gifts. Then I invite the volunteers to trade their gift with any of the other volunteers. Usually around half of them exchange gifts. Then we re-rate the gifts for those who made an exchange, and voila! An increase in welfare (thus neatly illustrating the gains from trade). However, this time the experiment didn't go to plan, as none of the volunteers wanted to exchange their gifts. I should have realised at the time it was the result of the endowment effect. Making an exchange of gifts entails both a loss (giving up the original gift) and a gain (the exchanged gift) for each volunteer, but since losses are valued much higher than gains it takes a substantial improvement for both volunteers before a trade will make both of them better off. Mystery solved.

Anyway, if you have access to the Laibson and List paper (or their textbook with Acemoglu) I encourage you to read it.

The second paper that caught my eye was Kevin Murphy's (University of Chicago) article on "Gary Becker as a Teacher" (also gated). Also well worth a read if you have access - in addition to being a leading light in applying economics to a wide range of social phenomena, Becker was clearly an inspirational teacher as well. Murphy concludes his paper by saying:
In general, in many ways Becker taught a very traditional view of economics. He emphasized the maximization of stable preferences, the importance of understanding the underlying constraints, and the incorporation of markets into virtually every analysis. But he did it in his own special, unique, and most importantly, unapologetic way. He taught a course that was pure economics. It just took longer for many of us to realize that such an unabashed approach to economics was the way to go. It is a tremendous loss that future cohorts of students will not be able to get the full Becker treatment.
Read more on Gary Becker through the links here.

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