Nathan Berg

As-If Behavioral Economics: Neoclassical Economics in Disguise?

For a research program that counts improved empirical realism among its primary goals, it is surprising that behavioral economics appears indistinguishable from neoclassical economics in its reliance on “as-if” arguments. “As-if” arguments are frequently put forward in behavioral economics to justify “psychological” models that add new parameters to fit decision outcome data rather than specifying more realistic or empirically supported psychological processes that genuinely explain these data. Another striking similarity is that both behavioral and neoclassical research programs refer to a common set of axiomatic norms without subjecting them to empirical investigation. Notably missing is investigation of whether people who deviate from axiomatic rationality face economically significant losses. Despite producing prolific documentation of deviations from neoclassical norms, behavioral economics has produced almost no evidence that deviations are correlated with lower earnings, lower happiness, impaired health, inaccurate beliefs, or shorter lives. We argue for an alternative non-axiomatic approach to normative analysis focused on veridical descriptions of decision process and a matching principle – between behavioral strategies and the environments in which they are used – referred to as ecological rationality. To make behavioral economics, or psychology and economics, a more rigorously empirical science will require less effort spent extending “as-if” utility theory to account for biases and deviations, and substantially more careful observation of successful decision makers in their respective domains.

Normative Behavioral Economics

This paper addresses the question of why, in spite of its recent success, behavioral economics does not influence most discussions about how economic policy ought to be made. Failing to penetrate into contemporary discourse on leading policy issues is a serious problem, because behavioral techniques often point to policy prescriptions that are at odds with the prescriptions which follow from models using more standard behavioral assumptions. By comparing how the universe of possible policy implications changes when different methodological approaches are used, this paper demonstrates a systematic link between methodology and the range of policy prescriptions that can be socially desirable. Because of this link, the methodological multiplicity of behavioral economics, and the ideological pluralism which it supports, favor the use of normative behavioral economics. This follows from the basic economic principle of diversification: a policy prescription that reflects averaging over a number of distinct kinds of errors (one for each methodology) is less likely to wander far off target than one generated by a single method.

Psychology Implies Paternalism? Bounded Rationality May Reduce the Rationale to Regulate Risk-Taking

Behavioral economists increasingly argue that violations of rationality axioms provide a new rationale for paternalism – to “de-bias” individuals who exhibit errors, biases and other allegedly pathological psychological regularities associated with Tversky and Kahneman’s (in Science 185:1124–1131, 1974) heuristics-and-biases program. The argument is flawed, however, in neglecting to distinguish aggregate from individual rationality. The aggregate consequences of departures from normative decision-making axioms may be Pareto-inferior or superior. Without a well-specified theory of aggregation, individual-level biases do not necessarily imply losses in efficiency. This paper considers the problem of using a social-welfare function to decide whether to regulate risk-taking behavior in a population whose individual-level behavior may or may not be consistent with expected utility maximization. According to the social-welfare objective, unregulated aggregate risk distributions resulting from non-maximizing behavior are often more acceptable (i.e., lead to a weaker rationale for paternalism) than population distributions generated by behavior that conforms to the standard axioms. Thus, psychological theories that depart from axiomatic decision-making norms do not necessarily strengthen the case for paternalism, and conformity with such norms is generally not an appropriate policy-making objective in itself.

Same-sex sexual behaviour: US frequency estimates from survey data with simultaneous misreporting and non-response

Survey-based research concerning sexual behaviour almost inevitably confronts the simultaneous problems of misreporting and non-response. These problems lead to disparities among estimates of the number and characteristics of those who engage in same-sex sexual behaviour. This paper proposes a statistical model to consistently estimate the frequency of same-sex sexual behaviour in the presence of non-ignorable misreporting and non-response. The model is fitted using 1991–2000 General Social Survey data. Frequency estimates corrected for simultaneous misreporting and non-response are reported. According to the model, 7.1% of US males and 4.1% of females – 15.8 million individuals – are not exclusively heterosexual. Allowing for misreporting and non-response increases the estimated same-sex frequency by more than four million. The model reveals new patterns between misreporting and non-response probabilities and standard demographic variables such as age and income.

Democracy Under Uncertainty: The ‘Wisdom of Crowds’ and the Free-Rider Problem in Group Decision Making

We introduce a game theory model of individual decisions to cooperate by contributing personal resources to group decisions versus by free-riding on the contributions of other members. In contrast to most public-goods games that assume group returns are linear in individual contributions, the present model assumes decreasing marginal group production as a function of aggregate individual contributions. This diminishing marginal returns assumption is more realistic and generates starkly different predictions compared to the linear model. One important implication is that, under most conditions, there exist equilibria where some, but not all members of a group contribute, even with completely self-interested motives. An agent-based simulation confirms the individual and group advantages of the equilibria in which behavioral asymmetry emerges from a game structure that is a priori perfectly symmetric for all agents (all agents have the same payoff function and action space, but take different actions in equilibria). And a behavioral experiment demonstrates that cooperators and free-riders coexist in a stable manner in groups performing with the non-linear production function. A collateral result demonstrates that, compared to a – dictatorial decision scheme guided by the best member in a group, the majority-plurality decision rules can pool information effectively and produce greater individual net welfare at equilibrium, even if free-riding is not sanctioned. This is an original proof that cooperation in ad hoc decision-making groups can be understood in terms of self-interested motivations and that, despite the free-rider problem, majority-plurality decision rules can function robustly as simple, efficient social Democracy Under Uncertainty.

The consistency and ecological rationality approaches to normative bounded rationality

This paper focuses on tacit versus explicit uses of plural performance metrics as a primary methodological characteristic. This characteristic usefully distinguishes two schools of normative analysis and their approaches to normative interpretations of bounded rationality. Both schools of thought make normative claims about bounded rationality by comparing the performance of decision procedures using more than one performance metric. The consistency school makes tacit reference to performance metrics outside its primary axiomatic framework, but lexicographically promotes internal axiomatic consistency as the primary, and in most cases sufficient, normative outcome with which to undertake welfare comparisons. The consistency schools axiomatization program, in both neoclassical and behavioral forms, pre-commits to welfare interpretations that follow a hierarchy of rationalities based on the stringency of restrictions that different axiomatizations impose on choice data. In contrast, the ecological rationality school explicitly adopts multiple, domain-specific performance metrics, reflecting the view that adequate descriptions of well-being are irreducibly multivariate (i.e., non-scalar).

Inconsistency Pays?: Time-Inconsistent Subjects and EU Violators Earn More

Experimental choice data from 881 subjects based on 40 time-tradeoff items and 32 risky choice items reveal that most subjects are time-inconsistent and most violate the axioms of expected utility theory. These inconsistencies cannot be explained by well-known theories of behavioral inconsistency, such as hyperbolic discounting and cumulative prospect theory. Aggregating expected payoffs and the risk associated with each subjects’ 72 choice items, the statistical links between inconsistency and total payoffs are reported. Time-inconsistent subjects and those who violate expected utility theory both earn substantially higher expected payoffs, and these positive associations survive largely undiminished when included together in total payoff regressions. Consistent subjects earn lower than average payoffs because most of them are consistently impatient or consistently risk averse. Positive payoffs from inconsistency cannot, however, be fully explained by greater risk taking. Controlling for the total risk of each subject’s risk choices as well as for socio-economic differences among subjects, time inconsistent subjects earn significantly more money, in statistical and economic terms. So do expected utility violators. Positive returns to inconsistency extend outside the domain in which inconsistencies occurs, with time-inconsistent subjects earning more on risky choice items, and expected utility violators earning more on time-tradeoff items. The results seem to call into question whether axioms of internal consistency—and violations of these axioms that behavioral economists frequently focus on—are economically relevant criteria for evaluating the quality of decision making in human populations.

Does Consistency Predict Accuracy of Beliefs?: Economists Surveyed About PSA

Subjective beliefs and behavior regarding the Prostate Specific Antigen (PSA) test for prostate cancer were surveyed among attendees of the 2006 meeting of the American Economic Association. Logical inconsistency was measured in percentage deviations from a restriction imposed by Bayes’ Rule on pairs of conditional beliefs. Economists with inconsistent beliefs tended to be more accurate than average, and consistent Bayesians were substantially less accurate. Within a loss function framework, we look for and cannot find evidence that inconsistent beliefs cause economic losses. Subjective beliefs about cancer risks do not predict PSA testing decisions, but social influences do.

Decision-making environments in which unboundedly rational decision makers choose to ignore relevant information

This paper advances the claim that ignoring relevant information is sometimes consistent with good decision making. Although that finding is not new, the argument presented here is. In contrast with bounded rationality models, the decision-making model in this paper presupposes no cognitive constraints or costs associated with processing available information. The paper identifies a class of decision-making environments characterised by asymmetric payoffs and probabilities - a property which gives rise to optimal decision rules that ignore relevant information. In other words, optimal decision procedures used by omniscient agents are sometimes independent of variables that objectively predict future outcomes.

Imitation in Location Choice

Under the assumption of perfect competition, it is difficult to avoid the conclusion that abandoned properties and long undeveloped neighborhoods remain that way because they are unprofitable. In contrast, this paper introduces a model in which firms systematically overlook neighborhoods with little commercial activity because of a positive informational externality motivating later movers to condition choice of location on earlier movers’ locations. When this occurs, firms sometimes find it profitable to imitate early movers’ locations even though privately acquired information suggests locating elsewhere. The model facilitates normative analysis of imitation in location choice by explicitly quantifying losses in aggregate efficiency following a shift from centralized to decentralized regimes. The model provides a tool for investigating the hypothesis of inefficient lock-in as it relates to neighborhoods in U.S. urban centers that remain underutilized despite the presence of profitable business prospects.