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Psychology and Economics (Lecture 1) David Laibson January 24, 2017 Outline: 1. Who are we? 2. Psychology and economics: denition 3. An example: laptops in class 4. Opportunity to politely leave 5. Logistics and syllabus — reminder about PS#1 due Thursday in class 1 Who are we? David Laibson • Harvard undergraduate (Econ.), MIT PhD (Econ.) • elds: psychology and economics, macroeconomics, consumption, nance, bounded rationality, intertemporal choice, neuroeconomics, genetics • methods: theory, experiments, eld empirics, biosocial science Tomasz Strzalecki • University of Warsaw undergraduate (Econ.), Northwestern PhD (Econ.) • elds: psychology and economics, bounded rationality, decision theory, microeconomic theory • methods: theory, experiments 2 Psychology and economics (aka behavioral economics) Denition: Psychology and economics is a eld of academic research that studies the joint in uences of psychological and economic factors on behavior. Some basic methodological principles that set behavioral economists apart from many mainstream economists: • Use of experiments. • Interest in microfoundations of decision-making (preferences, beliefs, cognition, neuroscience, genomics, biology). • Skepticism of ‘as if’ economics. • Attention to research being done by natural scientists and social scientists outside economics, especially psychologists (social psychology, cognitive psychology, judgment and decision-making, neuroscience, genomics). Most researchers in the eld of psychology and economics believe that the classical economic model of behavior (Homo Economicus) is too extreme. • Too rational — People occassionally make mistakes and those mistakes are predictable. • Too selsh — People do not care only about themselves (or their family). • Too willful — Good intentions are not always aligned with our subsequent actions. Note that assuming perfect rationality, perfect selshness and perfect willpower is relatively simple. Extreme cases (“limit cases”) like perfect rationality tend to be simple. Making an economic model psychologically more realistic usually means making the model more complex, and harder to analyze. • 2D vs. 3D • Falling bodies in a vacuum vs. falling bodies slowed by air resistance • Newtonian physics vs. General Relativity Despite these dierences, we are not fundamentally opposed to mainstream economics. We share three key principles with mainstream economists. • Decision makers are highly sophisticated. • Markets and incentives play a key role in shaping behavior. • Markets allocate resources well most of the time. We also share three key methodological principles with mainstream economists. • Use of eld data to supplement experiments. • Mathematical models are a useful way of representing knowledge. • Models should “nest” the special case of perfect rationality. We nd it helpful to distinguish three dierent categories of economic analysis: • Positive economics: what has occurred and what will occur? — description and prediction • Normative economics: what should policymakers do? • Prescriptive economics: what advice should we give to individual economic agents if we are trying to help them privately optimize? • Most economists lump normative and prescriptive together and call the total package normative. I nd it helpful to separate the two. What is a model? A model is a simplied representation of the world. • Most models are based on assumptions that are known to be only approximately true (and exactly false). • For example, consider the most commonly used models of the earth: at, spherical, ellipsoid, point mass. • These models do not account for the bumps and grooves. • A perfect replica of the earth would reproduce every contour, but such a representation would be impractical for most purposes. What are the properties of a good model? (Gabaix and Laibson, 2007) 1. Parsimony: is it simple? 2. Tractability: is it easy to work with? 3. Conceptual insightfulness: does it illuminate some important idea? 4. Generalizability: can it be applied to many dierent settings? 5. Falsiability: does it make predictions? 6. Empirical consistency: is it consistent with known facts? 7. Predictive precision: does it make sharp predictions? 3 An example: electronic devices in class. “Classical” economic considerations: Psychological considerations: Policy solutions? • laissez-faire • educational intervention (nancial literacy interventions) • ban laptops (with special exceptions for students with a medical need) • make a no-laptop section the default and let students opt-out • make a laptop section the default and let students opt-out • set up an active choice between the laptop and no-laptop sections Nuances: • Should we vote on the regime we want? • What would be the voting procedure? • Should the instructor choose the policy? • If so, how should dierent students’ well-being be measured/estimated and aggregated? • What evidence would you use to identify the optimal policies? 4 Opportunity to politely leave 5 Logistics and Syllabus Lecture Review 1. Who are we? 2. Psychology and economics: denition 3. An example: laptops in class. 4. Opportunity to politely leave 5. Logistics and syllabus — remember Problem Set 1 is on the course web-site and due Thursday in class.