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Lecture 40 Policy Implications of Mental Accounting II

3. Labor Markets

  • Money illusion: wage cut vs (increase/inflation <1)
  • Lay off instead of wage cuts (in severe recessions)
  • Optimal solution depends on labor laws and customs
  • Europe, reduce wage by reducing length of working week (as firing causes high compensation payments)… egalitarian work-sharing (a cut for everyone)
  • Higher wage \(\implies\) longer work hours (opportunity cost of leisure is higher at a higher wage)
  • But, higher work rate will lead to a lower level of hours worked (because their evaluation is over a weekly bracket which makes them 'target workers'. After the target is reached, they stop working)

4. Financial markets

  • Diversification heuristic
  • Frequency of evaluation in MLA context

Why market will eliminate behavioral deviations from the standard model:

  1. Aggregation: Individual deviations will cancel each other out in the market as a whole.
  2. Experience and expertise: Most important agents in fin markets are skilled
  3. Competition: biased agents are driven out due to bad decisions.

  • Some studies: biases disappear. One study: experts show even more bias.

    • Chicago Board of Trade showed greater MLA tendencies than students

  • Further research into the EPP

    • Weakness of original model: not intertemporal

5. Government Policy

  • Govt wants to nudge…
  • Decisions take place within a frame
    • e.g. allowance paid once/twice a month?

Public Services

  • Many countries, services like health care have a mixed provision (public + private)
  • Safety net for less privileged
  • Ensure choice structure is good else becomes confusing and cumbersome to choose
  • Context menu effects: people make suboptimal decisions
    • e.g. continue on a particular drug program even if a better/cheaper is available.
  • Contributions to pension funds
    • Tax incentives
    • If more people are covered by private provision, strain on public sector is reduced
      • strain due to aging population in developing countries

Government influence

on market behavior… how?
- mandate or encourage changes in framing of choices
- e.g. Retirement savings
- (change the default option to enrolling rather than not enrolling)
- But contributions at low level… :(
- Integrate savings plan with spending account… (e.g. in credit card payments, when you pay, you save a bit too)
- Takes advantage of principle of integrating losses (diminishing marginal sensitivity)1

  • Default option = 'normal' (causes bias)… Status quo bias

    • In most countries, you "opt-in" for organ donation, but there is shortage of organs.
    • So, let the default be changed… so that people have to "opt-out" voluntarily.

  • Tax and transfer policies

    1. Unexpected income is more likely spent and perceived as unearned (hence no reluctance)
    2. Reversal of losses \(\gg\) Gains (house money effect, and return to status quo)
      • Bottom line: Frame environmental policy, counter-terrorism and anti-obesity policy as returns to a previous and more desirable state** rather than a gain, with the current undesirable state.
    3. Smaller rebates are easily spent… less likely to be embarked/labeled for a particular budget category.
      • So, spread out rebate payments… make smaller payments, while keeping total rebate bill same.

  • People don't pay attention, 'yeah, whatever' heuristic… a special message is required.

    • Salience in environmental policy
      • Cars sold should advertise their fuel economy figures.
  • Think like the firm and do the opposite… smoking habits are costly, highlight the integrated expenditure annually on smoking.

Summary

  • MA is a set of cognitive operations
  • used by individuals and households to code, categorize and evaluate financial activities.

  • Three main aspects

    1. Perception of outcomes; making and evaluating decisions
    2. Assignment of activities to specific accounts
    3. Determination of time periods \(\to\) which account relates to which time period.

  • Transactions confer two types of utility

    • Acquisition utility
    • Transaction utility

  1. Remember, that a small loss hits hard, but if you combine many of those small losses, they would hit us less hard than them hitting us individually. ↩