Diamond Peter - Behavioral Economics and Its Applications

Behavioral Economics and Its Applications

Peter Diamond
Hannu Vartiainen

Editors

Copyright 2007 by Princeton University Press

Published by Princeton University Press,
41 William Street, Princeton, New Jersey 08540

In the United Kingdom: Princeton University Press,
3 Market Place, Woodstock, Oxfordshire OX20 1SY

All Rights Reserved

ISBN-13: 978-0-691-12284-7 (alk. paper)
ISBN-10: 0-691-12284-9 (alk. paper)

Library of Congress Control Number: 2006936337

A catalogue record for this book is available from the British Library

This book is based on the Yrj Jahnsson Foundation 50th Anniversary
Conference held on June 2223, 2004, in Espoo, Finland

This book has been composed in Times

Typeset by T&T Productions Ltd, London

Printed on acid-free paper

pup.princeton.edu

Printed in the United States of America

10 9 8 7 6 5 4 3 2 1

Peter Diamond and Hannu Vartiainen

B. Douglas Bernheim and Antonio Rangel

Sendhil Mullainathan

Christine Jolls

Truman F. Bewley

Richard G. Frank

Colin F. Camerer and Ulrike Malmendier

The Yrj Jahnsson Foundation was established in 1954. Mrs. Hilma Jahnsson, the spouse of the deceased professor of economics Yrj Jahnsson, donated a generous amount of their joint estate as initial capital for the foundation. The purpose of the foundation is to promote Finnish research in economics, medicine, and health economics, and to maintain and support Finnish educational and research facilities in these fields.

International contacts are essential to the foundation, and the Finnish economics community has benefited from lectures and seminars by a long list of internationally renowned economists. Since 1963 the foundation has arranged the Yrj Jahnsson Lectures in Economics, one of the most distinguished scholarly lecture series in this field. The well-known Yrj Jahnsson Award in Economics is given every two years to a young economist who has made an important contribution to economics in Europe. The foundation organizes a high-profile conference to celebrate each decennial anniversary.

This volume has its basis in an international conference held in Helsinki on June 2223, 2004 to celebrate the 50th anniversary of the Foundation. As the title indicates, the aim of the conference was to discuss the role of behavioral economics in applied fields. It is important to understand how psychologically plausible features of human behavior affectand should affectthe design and working of economic institutions. However, it is equally important to get feedback from the applied arena to see which behavioral tendencies really matter, and to see how the framework should be developed further.

I am grateful to Professor Peter Diamond of the Massachusetts Institute of Technology, who acted as the program chairman. He did a marvelous job in choosing the set of topics and speakers. I also thank Professor Bengt Holmstrm, also of the Massachusetts Institute of Technology, whose input in the initial phase of the conference was very important. I am grateful to Professor Seppo Honkapohja, University of Cambridge, U.K., for helping us to shape the conference and this volume through his experience and connections. Finally, I thank all the speakers and commentators, and the Scientific Director of the foundation, Dr. Hannu Vartiainen, for making the conference such a successful event.

TIMO LAATUNEN
Chairman of the Board

Ian Ayres
Yale Law School

Ian Ayres is the William K. Townsend Professor at Yale Law School. He has published eight books and hundreds of articles on a wide variety of topics and is a regular contributor to public radios Marketplace and a columnist for Forbes.

B. Douglas Bernheim
Stanford University

B. Douglas Bernheim is the Edward Ames Edmonds Professor of Economics at Stanford University. He has published extensively in public economics, political economy, behavioral economics, industrial organization, financial economics, game theory, and contract theory. He is a Fellow of the American Academy of Arts and Sciences, a Fellow of the Econometric Society, a recipient of a John Simon Guggenheim Memorial Foundation Fellowship, an Alfred P. Sloan Foundation Research Fellowship, and an NBEROlin Research Fellowship. He has served as the Director of the Stanford Institute for Theoretical Economics, and as Co-Editor of the American Economic Review.

Truman F. Bewley
Yale University

Truman F. Bewley received a PhD in economics in 1970 and a PhD in mathematics in 1971, both from the University of California, Berkeley. He is now the Alfred C. Cowles Professor of Economics at Yale University. He has contributed to general equilibrium theory and has written a book, Why Wages Dont Fall During a Recession (1999) based on over 300 interviews with businesspeople, labor leaders, and other decision makers important to the labor market.

Colin F. Camerer
California Institute of Technology

Colin F. Camerer is the Axline Professor of Business Economics at Caltech. He studies the behavioral economics of decisions, strategic thinking, and markets, using a combination of experimental methods and field data. His recent work explores the neural foundations of economics. He has edited or written four books, including Behavioral Game Theory (2003) and published more than 100 articles in journals and books. He is a Fellow of the Econometric Society and was 20056 President of the Society for Neuroeconomics.

Anne Case
Princeton University

Anne Case is a Professor of Economics and Public Affairs at Princeton University, where she serves as Director of the Research Program in Development Studies. Her recent research has focused on the two-way links between economic status and health status, both in the United States and in developing countries. She has published extensively on health and well-being in professional journals, and she is currently serving on the editorial boards of the American Economic Review and the World Bank Economic Review.

Michael D. Cohen
University of Michigan

Michael D. Cohen is the William D. Hamilton Collegiate Professor of Complex Systems, Information, and Public Policy at the University of Michigan. He has published numerous articles on organizational decision-making in journals such as Rationality and Society and Nature. He is the coauthor (with Robert Axelrod) of Harnessing Complexity: Organizational Implications of a Scientific Frontier. His empirical work includes field studies of decision processes and laboratory experiments showing the foundations of group routines in individual procedural memory. He has served as an external faculty member of the Santa Fe Institute and as a long-term consultant at the Xerox Palo Alto Research Center.

Peter Diamond
Massachusetts Institute of Technology

Peter Diamond is an Institute Professor and Professor of Economics at MIT, where he has taught since 1966. He has been President of the American Economic Association, of the Econometric Society, and of the National Academy of Social Insurance. He is a Fellow of the American Academy of Arts and Sciences and a Member of the National Academy of Sciences. He has written on behavioral economics, public finance, social insurance, uncertainty and search theories, and macroeconomics.