What’s holding Behavioral Economics back? And what can be done about it? The fields of Behavioral Economics and Behavioral Law and Economics have each supplied important and useful insights. But the state of knowledge has changed rapidly across the decades since Tversky and Kahneman first highlighted how people sometimes systematically depart from predictions of the standard expected utility model in neoclassical economics. Those changes now render it uncomfortably obvious that Behavioral Economics, and those who rely on it, are falling behind with respect to new developments in other disciplines that also bear directly on the very same mysteries of human decision-making. This chapter identifies four problems for Behavioral Economics. It explores their causes. It then suggests and illustrates ways around them, including a path for integrating multi-disciplinary insights. The chapter provides concrete recommendations that can help to move these important schools of thought forward, in light of developments in other fields.
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Valuation gaps and exchange asymmetries are among the most widely studied phenomena in the field of behavioral economics. This chapter presents the current state of the social science literature related to observed reluctance to trade. Numerous theories have been proposed and only a few might be safe to rule out based on the evidence to date. A number of theories have been developed and tested by both economists and psychologists including endowment theory, substitution theory, expectation theory, preference uncertainty, mere-ownership theory, enhancement theory, subject misconceptions, and regret avoidance. The chapter walks through each proposed theory, cataloging the evidence for and against. While some theories have garnered more support from the data than others, no single theory yet deserves the title of leading theory. As this chapter makes clear, much more work is required to develop a theory or set of theories worthy of designation as the leading theory.
Benjamin Ho and David Huffman
Understanding the nature of trust has substantial implications for thinking about the economics of law. In this chapter the authors consider the interaction between laws and trust. They pursue this inquiry by looking at the growth of the behavioral economics and organizational economics literatures. After describing a model of trust, the authors review results on the relationship between trust and growth from the development and macroeconomics empirical literatures. The chapter then turns to evidence from experiments that shed light on mechanisms that may link trust and the law and help us understand why in some circumstances they may be complementary and in others substitutes. The authors draw some preliminary conclusions about the factors that might contribute to explaining complementarity of trust and the law at the macro level. The chapter ends with a discussion of some specific laws, and how these interact with trust.
How to design punishment mechanisms to maintain social order is a central question in law. Xiao reviews recent behavioral economic research on how punishment influences prosocial behavior, much of which provides evidence that punishment can have a negative effect on cooperation. She discusses several factors that can lead to the detrimental effect of punishment and suggests some solutions. She argues that the effectiveness of punishment is closely connected to its role in expressing social norms. She ends the chapter by reviewing some recent research on social norms and suggesting punishment and social norm instruments are complementary in promoting cooperation.
Sanjit Dhami and Ali al-Nowaihi
Dhami and Ali al-Nowaihi consider the applications of prospect theory to crime and punishment. The authors apply prospect theory to a generic model of crime and discuss the implications. They discuss two problems in depth. The first is the tax evasion problem. The second is a foundational result in law and economics, known as the Becker proposition. They also note the limitations of the framework.
Behavioral law and economics’ effort to replace standard microeconomic assumptions with more realistic, yet still simple assumptions—without jettisoning a basic economic orientation toward behavior that emphasizes prices and utility maximization—has led to the acceptance of an oversimplified view of human judgment and decision-making. Supposedly descriptive claims found in Behavioral Law and Economics often ignore heterogeneity in results and interactions among variables, emphasize the existence of effects over the size of effects and their practical significance, avoid open questions about external validity, and embrace vague labels rather than delve into the multiple psychological processes and other non-psychological factors that may cause or account for behavior. The price of this abstraction is a lack of predictive and explanatory validity and an inability to provide reliable policy guidance.
Gary Charness and Gregory DeAngelo
Experimental methods have become increasingly prominent in the social sciences. While field data are indeed rich and abundant, reflecting a variety of environmental factors, disentangling these factors is difficult, if not impossible. The intertwining of potential causal factors in the field is particularly acute in law and economics. Laboratory experiments have some important advantages over other approaches. The purpose of this chapter is to familiarize the reader with a handful of the vast array of techniques experimentalists use to explore theories related to law and decision-making in (mock) legal environments. The authors describe a set of experiments conducted to study decisions of judges, juries and attorneys and review experiments designed to study the effects of law enforcement. They also describe a set of experiments that study the bargaining behavior of principals and their agents and the role that communication plays in negotiations.
Claudia M. Landeo
In tort litigation, delayed settlement imposes high costs on the parties and society. An appropriate design of litigation institutions and tort reform requires a good knowledge of the factors that affect litigants’ behavior. Both theoretical and experimental law and economics, which represent the cornerstones of the application of the scientific method, enhance our understanding of the effects of litigation institutions and tort reform on settlement and deterrence. This chapter evaluates the interaction between theoretical and experimental law and economics in the study of tort litigation institutions. Special attention is devoted to liability, litigation and tort reform institutions, and behavioral factors that might affect an impasse. The analysis suggests a productive interaction between theoretical and experimental law and economics. In particular, findings from experimental economics work on litigation institutions indicate the presence and robustness of cognitive biases, and provide evidence of the effects of litigants’ biased beliefs on the likelihood of impasse.
Joshua C. Teitelbaum and Kathryn Zeiler
The subfield of behavioral economics, while still quite young, has made important contributions to our understanding of human behavior. Through a cycle of theory development and empirical investigation, work in behavioral economics taps into lessons from psychology with the goal of improving economics’ predictive power. While the focus diverges from that of neoclassical economics, the best work in both subfields has much in common. The most useful insights are produced by faithfully applying the scientific method—the development of explanations of behavior through repeated cycles of data collection and hypothesis testing. Gains in knowledge are incremental, and skepticism is encouraged until assumptions built into theory are able to hold up against data collected in multiple environments. In addition, both subfields strive to integrate relevant concepts—e.g., psychological concepts in the case of behavioral economics—into models that produce well-defined, testable, and falsifiable predictions. While some have characterized the mission of behavioral economics as an attempt to abandon rational choice theory and replace it with more realistic assumptions that reflect human fallibility, many behavioral economics models that find strong support in existing data assume a set of rational but non-standard preferences (Zeiler, forthcoming). In fact, a great many works in behavioral economics contain multiple theories able to explain large swaths of existing data, some of which assume individuals make systematic, predictable mistakes, while others assume the error-free expression of non-standard, rational preferences. The empiricist’s role is to discover ways to separate the theories by developing or observing environments in which the theories lead to divergent predictions. In some literatures models that assume mistake-making are in the lead, and in others models assuming non-standard preferences seem to best explain existing data.