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Traditional economists also assume human beings have complete self-control. But, for instance, people will buy cigarettes by the pack instead of the carton even though the carton saves them money, to keep usage down. They purchase locks for their refrigerators and overpay on taxes to force themselves to save. In other words, we protect ourselves from our worst temptations but pay a price to do so. One way behavioral economists are responding to this is by setting up ways for people to keep themselves free of these temptations. This includes what are called “nudges” toward more rational behavior rather than mandatory regulations from government. For example, up to 20 percent of new employees do not enroll in retirement savings plans immediately, because of procrastination or feeling overwhelmed by the different choices. Some companies are now moving to a new system, where employees are automatically enrolled unless they “opt out.” Almost no-one opts out in this program and employees begin saving at the early years, which are most critical for retirement.

Another area that seems illogical is the idea of mental accounting, or putting dollars in different mental categories where they take different values. Economists typically consider dollars to be fungible    , or having equal value to the individual, regardless of the situation.

You might, for instance, think of the $25 you found in the street differently from the $25 you earned from three hours working in a fast food restaurant. The street money might well be treated as “mad money” with little rational regard to getting the best value. This is in one sense strange, since it is still equivalent to three hours of hard work in the restaurant. Yet the “easy come-easy go” mentality replaces the rational economizer because of the situation, or context, in which the money was attained.

In another example of mental accounting that seems inconsistent to a traditional economist, a person could carry a credit card debt of $1,000 that has a 15% yearly interest cost, and simultaneously have a $2,000 savings account that pays only 2% per year. That means she pays $150 a year to the credit card company, while collecting only $40 annually in bank interest, so she loses $130 a year. That doesn’t seem wise.

The “rational” decision would be to pay off the debt, since a $1,000 savings account with $0 in debt is the equivalent net worth, and she would now net $20 per year. But curiously, it is not uncommon for people to ignore this advice, since they will treat a loss to their savings account as higher than the benefit of paying off their credit card. The dollars are not being treated as fungible so it looks irrational to traditional economists.

Which view is right, the behavioral economists’ or the traditional view? Both have their advantages, but behavioral economists have at least shed a light on trying to describe and explain behavior that has historically been dismissed as irrational. If most of us are engaged in some “irrational behavior,” perhaps there are deeper underlying reasons for this behavior in the first place.

"eeny, meeny, miney, moe"—making choices

In what category did consumers worldwide increase their spending during the recession? Higher education. According to the United Nations Educational, Scientific, and Cultural Organization (UNESCO), enrollment in colleges and universities rose one-third in China and almost two-thirds in Saudi Arabia, nearly doubled in Pakistan, tripled in Uganda, and surged by three million—18 percent—in the United States. Why were consumers willing to spend on education during lean times? Both individuals and countries view higher education as the way to prosperity. Many feel that increased earnings are a significant benefit of attending college.

Bureau of Labor Statistics data from May 2012 supports this view, as shown in [link] . They show a positive correlation between earnings and education. The data also indicate that unemployment rates fall with higher levels of education and training.

The impact of education on earnings and unemployment rates, 2012

The graph shows the unemployment rate and median weekly earnings in 2012 for various levels of education. People with professional degrees made around $1,735 a week and suffered a 2.1% unemployment rate. People with doctoral degrees made around $1,624 a week and suffered a 2.5% unemployment rate. People with Master’s degrees made around $1,300 a week and suffered a 3.5% unemployment rate. People with Bachelor’s degrees made around $1,066 a week and suffered a 4.5% unemployment rate. People with Associate’s degrees made around $785 a week and suffered a 6.2% unemployment rate. People with some college, no degree made around $727 a week and suffered a 7.7% unemployment rate. People with a high school diploma made around $652 a week and suffered an 8.3% unemployment rate. People with less than a high school diploma made around $471 a week and suffered a 12.4% unemployment rate.
Those with the highest degrees in 2012 had substantially lower unemployment rates whereas those with the least formal education suffered from the highest unemployment rates. The national median average weekly income was $815, and the nation unemployment average in 2012 was 6.8%. (Source: Bureau of Labor Statistics, May 22, 2013)

Key concepts and summary

When making a choice along the intertemporal budget constraint, a household will choose the combination of present consumption, savings, and future consumption that provides the most utility. The result of a higher rate of return (or higher interest rates) can be a higher quantity of saving, the same quantity of saving, or a lower quantity of saving, depending on preferences about present and future consumption. Behavioral economics is a branch of economics that seeks to understand and explain the "human" factors that drive what traditional economists see as people's irrational spending decisions.

References

Holden, Sarah, and Daniel Schrass. 2012. “The rose of IRAs in U.S Households’ Saving for Retirement, 2012.” ICI Research Perspective 18.8 (2012). http://www.ici.org/pdf/per18-08.pdf.

Kahneman, Daniel and Amos Tversky. “Prospect Theory: An Analysis of Decision under Risk.” Econometrica 47.2 (March 1979) 263-291.

Thaler, Richard H. “Shifting Our Retirement Savings into Automatic.” The New York Times , April 6, 2013. http://www.nytimes.com/2013/04/07/business/an-automatic-solution-for-the-retirement-savings-problem.html?pagewanted=all.

UNESCO Institute for Statistics. “Statistics in Brief / Profiles” Accessed August 2013. http://stats.uis.unesco.org/unesco/TableViewer/document.aspx?ReportId=121&IF_Language=en&BR_Country=5580.

Questions & Answers

Method of distribution
Emma Reply
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Nuhu
hi
Paramount
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raphael
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Nuhu
Jamaica
Paramount
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Nuhu
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Paramount
am Nuhu from Ghana and u?
Nuhu
To become an Economist
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Junior
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Paramount
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Nuhu
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tapir
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praveen
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praveen
kuul
Nuhu
How is everyone here? it is King Wobokolo saying hi from Uganda
Lugumya
juxtapose indisputable fact of scarcity
Adebayo Reply
what is opportunity cost?
Humphrey
Opportunity cost is the want sacrificed to satisfy another want.
Joseph
opportunity cost is a forgone alternative, example if a consumer wants to buy a book Nd a pen but he does not have the money for both then he drops the pen Nd buys the book..... so the pen that he dropped Is the opportunity cost
chimdindu
a.o.a..
Imran
opportunity cost is the alternative forgone or goods that is left on satisfied in order to satify another want
richmond
it is also the satisfaction of a want with the expense of another want
richmond
what is surplus value theory
Ayunku
what does the law demand and supply states
Humphrey
hello
Nuhu
the law of demand state that at a higher price less is demanded and at low price more is demanded
Nuhu
the law supply state that at a higher price more is demanded and at a low price less is demanded
Nuhu
THE LAW OF DEMAND states that, All other things being equal, at a higher price, consumers demand less and at a lower price more is demanded. THE LAW OF SUPPLY states that, All other things being equal, producers produce more quantity at a higher price and less at a lower price.
Joseph
what is the law of diminishing returns?
Humphrey
the of diminishing returns state that the continues addition of fixed to a variable factor of production may lead to an increase in marginal production but at a point in time marginal production may diminished or falls
Nuhu
what is the equilibrium quantity
Zinna Reply
differentiate between equilibrium and equilibrium point
Adebayo
Leo Robinson's definition
Adejimi Reply
how is equilibrium defined in financial markets?
Babakura Reply
the concept of it
DALOM
Country A has export sales 20 billion, government purchases 1000billion, business investment is 50 billion, imports are 40billion, and consumption spending is 2000billin. What is the dollar value of GDP ?
Habtamu Reply
What are the method of distribution
Emma
what is determination of national income?
Waqar Reply
economic growth
Rukaiya
stock of capital
Rukaiya
we're RBI keep money with them
Anil
Y =C+l
Favour
evaluate the success affirmative action as one of south Africa's redress method
Tebatso Reply
what is market equilibrium
explorer Reply
it is a situation in which the supply of an item is exactly equal to it dd .
Ssmith
inder wat condition shld a firm stop production in both short n lungrun ?
Ssmith
what is 2nd degree price discrimination?
Ssmith
what is quantity
Tettey
what is quantity2
Deji Reply
An indefinite amount of something.
explorer
what is the opportunity cost of producing 20 loaves of bread?
Zinna
what is demand
Kaman Reply
in ordinary sense demand means desire
Khalid
demand in economics means both willingness as well as the ability to purchase a commodity by paying a price an also its actuall purchase
Khalid
what is absolute advantage
Khalid
demand refers to the various quantity of goods and services that consumers are willing and able to purchase at a particular period of time all other things been equal
Dela
The amount of a good or service that consumers are willing to buy at a particular price.
explorer
what is cost pull inflation?
oru
what is utility
oru
what is cost pull inflation?
oru
demand is economic principle referring to a consumer's desire and willingness to pay a price for a specific or service..
Babakura
utility is the among of certisfaction driving from using a comundity
Anas
pull cost of inflation hight population unemployment to some of The country members poor government system
Anas
what is a buffer scheme
Lukong
state the second law of demand and supply
Ahmadou Reply
state the law of diminishing marginal utility
Ahmadou
dt know WATS the answer
Rukundo
mention and explain two Bank I financial institutions and two non baking financial institutions
Onah Reply
wat is demand pull inflation
Tony Reply
Demand-pull inflation is asserted to arise when aggregate demandin an economy outpaces aggregate supply. It involvesinflation rising as real gross domestic product rises and unemployment falls, as the economy moves along the Phillips curve.
kevin
Perfectly elastic demand
Abubakar Reply
this is a form of demand where goods are demanded at a constant price
Rukundo
what inelastic demanding
Koire
demand of any good demanded more after a certain period. if a commodity prices may high and scarcity of that resources.
Anil
cannot demand more
Anil

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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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