Andrew Leigh: applying behavioural economics in policymaking

The idea of behavioural economics is not new, but the application to policymaking is now being seriously considered. Small nudges can have a big impact.

While I was in graduate school, two of my classmates, Stefano DellaVigna and Ulrike Malmendier, carried out a study on gym visits. They obtained data from three Boston gyms, and analysed the attendance patterns of members. Dividing annual fees by the number of visits, they found that the typical gym member spent $17 per visit, even though casual visits cost only $10. In total, the average member loses $600 compared with if they had just paid as a casual. The title of the paper? Paying not to go to the gym.

Over recent decades, the field of behavioural economics has taken off. Contrary to the assumptions of perfect rationality, full information, and a constant discount rate, economists have shown that we often make decisions that diverge from the standard model. A study of New York taxi drivers found that even though their hourly earnings are higher when it rains, they tend to go off shift earlier because they reach their target earnings.

Economists have shown that people are more likely to purchase a convertible if they test-drive it on a sunny day, and will pay more for a house with a swimming pool if the sale takes place in summer. Conversely, people are more likely to buy black cars on cloudy days, and more likely to enrol in a university if they visit its campus on a cloudy day (cloudiness increases the appeal of academic activities).

Unsurprisingly, firms have become adept at exploiting our biases. Vacation time-share exploits the fact that we tend to over-estimate the flexibility we have in timing our holidays. Credit cards have low or zero annual fees, but high interest rates for those who pay late. Mobile phone plans have low upfront costs, but rates rise rapidly for those who exceed their caps. Relative to subscription prices, People magazine (a classic impulse purchase) is much more expensive on the news-stand than Foreign Affairs. Las Vegas hotels can only afford to under-price their rooms because gambling is addictive.

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