Consumer Impact Assessment

APPENDIX A:

Behavioural economics in policy and regulatory development

Over the past two decades, academics in economics, psychology, sociology and game theory have been conducting research on how consumers actually think about and make decisions in the marketplace.

All market participants suffer to some degree from "bounded rationality" because of limited time, information, and/or computational and cognitive abilities. This leads to behavioural biases such as the use of rules of thumb ("heuristics") or routine habit to make decisions in the marketplace, which may lead in turn to mistakes. Market forces and consumer education can help to correct these mistakes. Nonetheless, these mistakes can have significant and lasting negative effects on market decisions and outcomes, and business and economic performance. They also prevent consumers from playing their full role in activating competition and innovation in the marketplace.

Two Important Behavioural Biases1

There are a number of behavioural biases that have been identified that have an impact on the way consumers make decisions. Two of the most important behavioural factors that analysts should be aware of when selecting, designing and assessing policy responses are: 1) how consumers may react to information and choice overload, and 2) how consumers may respond to various ways choice offerings are framed, and defaults are set.

1. Information and product choice overload (too much of a good thing)

For some products and markets, too many choices and overly complex offerings can be confusing and de-motivating. Consumers may put off a difficult decision, use a “rule of thumb” to reduce the number of choices, or stick with their current supplier for fear of making the wrong decision or because sorting it all out seems overwhelming.

Governments, independent consumer groups and other non-government organizations often provide policy responses to this situation by providing online calculators and other tools that help the consumer to wade through the complex and sometimes contradictory information. In other cases, very specific and simple disclosures tailored to an individual’s circumstances may be required to focus the consumer’s attention on key decision-making issues – for example, the long term cost of making a minimum payment on a credit card bill. Instruments such as these enable consumers to make more informed choices that yield them the highest benefit given their individual circumstances.

2. Framing effects

Consumer decisions are influenced by how information is presented, or framed, in contracts, advertising and sales pitches. How default options are defined and presented (consumers may endow the default option with positive attributes that it may not have), and whether a choice is presented as a loss or gain, or as a low-risk or high-risk, can radically influence the decision a consumer makes.

Implications for Policy Analysts

Analysts who have reason to believe that policy initiatives will fall short of their intended objectives due to activation of the above behavioural biases may wish to pay particular attention to how information interventions are designed and how choices are framed, and defaults set, when the policy change is rolled out to the public.

The excerpt below from the OECD’s Consumer Policy Toolkit gives examples where insights from behavioural work can help governments implement more effective policies.

Information interventions

"One type of policy intervention is to provide consumers with more information about a product or service, either directly or by mandating that sellers disclose information. In order to be effective, these types of interventions must be thought through carefully. For reasons that can be attributed either to traditional models of costly information search and processing or to behavioural models, more information is not always better for consumers. Additional information may distract consumers from more important factors, and it may overwhelm consumers and cause them to make decisions with less reflection rather than more. For example, in the United States, recently developed food-nutrition labels actually provide less information than previous labels, as a way of encouraging consumers to focus on the most important contents of food.2 In the financial area, regulation requires United States credit card companies to present key information to consumers in a table, in prescribed type sizes.3 Many countries have adopted very short, and often graphic, health warnings for cigarettes."

Default setting and framing

"Two clear examples of the importance of default setting in the context of consumer decision making are the adoption of “no-fault” automobile insurance and the sale of reserved seats on trains. In the 1990s, two American states, New Jersey and Pennsylvania, adopted new automobile insurance regulations that gave drivers the option of purchasing lower-cost insurance that limited their rights to sue in the case of an accident ('no-fault' insurance). In New Jersey, the lower-cost, “no-fault,” policy was the default, while in Pennsylvania the higher-cost option was the default. Some 70% of Pennsylvania drivers purchased the higher-cost policies, versus only 21% of New Jersey drivers.4 Even more dramatically, a national railway in Europe found that the share of online reservations that included a reserved seat rose by five-fold when the default was changed from “no reserved seat” to the more expensive 'reserved seat'.5 Finally, recent research on retirement savings in four countries shows how defaults influence retirement savings outcomes at all stages of the savings lifecycle, including savings plan participation, savings rates, asset allocation, and post-retirement savings distributions.6

In response to concerns about the role of defaults, the European Parliament and the Council have proposed a Directive on consumer rights which includes a clause limiting the use of default options in consumer contracts.7 Specifically, sellers would be required to obtain express consent from consumers for any payment that is in addition to the payment for the main contractual obligation, and could not rely on default options that require buyers to reject those options to avoid payment.

As discussed above, consumers sometimes “fail to choose” when presented with a large number of possible choices. This will leave them with the default option or status quo. It should be noted that, in most cases, private sellers want to avoid this situation, as consumers who fail to choose are consumers who fail to buy. For government policy makers, however, this means that if a programme’s goal is for consumers to make their own choices, the choices must be presented in a way that is manageable, both in terms of the number of choices and the way information is presented."

FOR FURTHER READING

Bertrand, M., Karlan, D., Mullainathan, S., Shafir, E., and Zinman, A. (2005). What’s Psychology Worth? A Field Experiment in the Consumer Credit Market. Economic Growth Center, Yale University, Discussion Paper 918.

Bertrand, M., Mullainathan, S., and Shafir, E. (2006). Behavioural Economics and Marketing in Aid of Decision- Making Among the Poor. Journal of Public Policy and Marketing, Vol. 25, No. 1.

Evans, P. (2008). In Search of the Marginal Consumer: The FIPRA Study. The FIPRA Group, Belgium, April 2008.

Gans, J. S. (2005:1). Protecting Consumers by Protecting Competition: Does Behavioral Economics Support This Contention? Competition AND Consumer Law Journal, 13, 1-11.

Gans, J. S. (2005:2). The Road to Confusopoly. Available on the Australia Competition and Consumer Commission (ACCC) Conference Website at http://www.accc.gov.au/content/index.phtml/itemId/658141/ fromItemId/3765.

Ireland, D. (2008). Empirical Research on Competition, Innovation and the Consumer. Prepared for the Office of Consumer Affairs, Industry Canada.

Iyengar, S. and Lepper, M. (2000). When Choice is Demotivating: Can One Desire Too Much of a Good Thing? Journal of Personality and Social Psychology Vol. 79 (6).

Johnson, E. J., Hershey, J., Meszaros, J., and Kunreuther, H. (1993). Framing, Probability Distortions, and Insurance Decisions. Journal of Risk and Uncertainty, Vol. 7 pp. 35-51.

Kahneman, D. (1994). New Challenges to the Rationality Assumption. Journal of Institutional and Theoretical Economics, 150, 18-36.

Kahneman, D., and Tversky, A. (1979). Prospect Theory: An Analysis of Decision under Risk. Econometrica, 47, 263-291.

OECD. (2010). Consumer Policy Toolkit. Paris.

Thaler, H. and Sunstein, C. R. (2008). Nudge: Improving Decisions About Health, Wealth and Happiness, Yale University Press, New Haven AND London.

Tversky, A., and Kahneman, D. (1991). Loss Aversion in Riskless Choice: A Reference Dependent Model Quarterly Journal of Economics, 106, 1039-1061.

Previous   Table of Contents   Next


Footnotes:

1 Refer to further reading list and other footnotes in this Annex for more information about behavioural economics.

2 USFTC (2008). Marketing Food to Children and Adolescents. July, available at www.ftc.gov/os/2008/07/P064504foodmktingreport.pdf.

3 USFRB (United States Federal Reserve Board) (2000). Federal Reserve System: 12 CFR Part 226 (Regulation Z; Docket No. R-1070), Truth in Lending – Final Rule, September 27, available at www.federalreserve.gov/boarddocs/press/boardacts/2000/20000928/attachment.pdf.

4 Johnson, E. J., Hershey, J., Meszaros, J. AND Kunreuther, H., A. (1993). Framing, Probability Distortions and Insurance Decisions. Journal of Risk and Uncertainty, 7, 35-53.

5 Goldstein, D. G., Johnson, E.I., Herrmann, A. and Heitmann, M. (2008). Nudge Your Customers Toward Better Choices. Harvard Business Review, 86(12), 99-105.

6 Beshears, J., Choi, J.J., Laibson, D., and Madrian, B.C. (2006). The Importance of Default Options for Retirement Savings Outcomes: Evidence from the United States, National Bureau of Economic Research, Working Paper 12009, January, www.nber.org/papers/w12009.

7 European Commission (2008). Proposal for a Directive of the European Parliament and the Council on Consumer Rights. COM(2008) 614/3, October 8, www.ec.europa.eu/consumers/rights/docs/Directive_final_EN.pdf.