Abstract
The premise of this article is that an understanding of psychology and other social science disciplines can inform the effectiveness of the economic tools traditionally deployed in carrying out the functions of government, which include remedying market failures, redistributing income, and collecting tax revenue. An understanding of psychology can also lead to the development of different policy tools that better motivate desired behavior change or that are more cost-effective than traditional policy tools. The article outlines a framework for thinking about the psychology of behavior change in the context of market failures. It then describes the research on the effects of a variety of interventions rooted in an understanding of psychology that have policy-relevant applications. The article concludes by discussing how an understanding of psychology can also inform the use and design of traditional policy tools for behavior change, such as financial incentives.
Highlights
Market failures occur when markets, left to their own devices, generate an inefficient allocation of resources: In short, when Q ≠ Q* in the familiar Econ 101 graphs of supply and demand
This article evaluates the implications of behavioral economics for the design of policy solutions to remedy market failures, redistribute resources, and collect tax revenue
There are at least three substantive insights that come from reviewing the behavioral economics literature as it relates to public policy
Summary
Market failures occur when markets, left to their own devices, generate an inefficient allocation of resources: In short, when Q ≠ Q* in the familiar Econ 101 graphs of supply and demand. The first, imperfect optimization, arises because consumers have limited attention and cannot possibly focus on all of the information relevant for all of the decisions they are called upon to make. They have limited computational capacity, which leads them to apply simplifying heuristics to complicated choice problems. Campbell et al (2011) note that mandated information provision or disclosure is a policy tool often used to mitigate asymmetric information, reduce search costs and limit market power, and remedy the underprovision of information-based public goods.
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