jamesz

Why do people form habits?

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Matt stormed back on to the blog yesterday with a post on the importance of habits in explaining human behaviour. Here I want to explore the way in which economists describe habits in a bit more depth. In particular, Matt asked why economists talk about habit persistence in such an ad hoc way. I don’t think it’s very ad hoc at all and I’ll try to explain why.

What are habits?

Having a habit means that you’re more likely to do something the more you’ve done it in the past. You’ve done it before, so that makes you more likely to do it now. The implication is that your current payoff from the activity depends upon how much you’ve done it in the past. The ‘how much you’ve done it in the past’ is what Matt refers to as ‘capital’, in the vein of Becker and Murphy’s seminal discussion of cigarettes.

How do economists describe habits?

Now the description in economic models is fairly obvious: your ‘utility’ depends not just on how much of something you get today, but also how much you got in the past. The easiest way to model that is to take the difference of today’s consumption and yesterday’s. That way, you want to consume more of something than you did yesterday, and consuming less than yesterday will make you less happy. Essentially, yesterday’s consumption can be thought of as the stock of ‘capital’ that Matt referred to. The more capital you’ve built up over time, the more you want to do the thing again today. Hence, with this simple mechanism, we get habit formation and persistence.

What I’ve just described is called ‘internal’ habit persistence because it depends on your personal consumption levels. However, it is easily generalised to societal habits by taking the stock of built up consumption to be average social consumption, or the consumption of one’s neighbours. Then we call it ‘external’ habit persistence.

Why do they do it that way?

So far so good, but the question Matt asked is why it’s modelled that way. As he pointed out, it’s not enough just to say it fits the observed behaviour: we also have to ask why. Now that we’ve got this far it’s actually fairly straightforward. Habit persistence is simply the dependence of your personal payoff on a reference level of consumption, as opposed to being dependent on the level of consumption.

Economists have studied reference dependence ever since the canonical work of Kahneman and Tversky on prospect theory back in 1979. They drew on the psychological evidence to show that people care not about the level of consumption but the change in consumption relative to some reference point. Now, there is a lot of discussion about what an appropriate reference point is. Depending on what the reference point is you can get very different behaviours, and there can hardly be a dozen different reference points (although some weighting across them may be plausible).

The main point for our discussion is that viewing habit persistence as the result of reference-dependent utility allows us to sheet it back to some empirical literature on psychology and behaviour.

Matt Nolan

Habit formation and the economic core

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I have repeatedly been informed that the “economic man” is a poor description of individuals, and given this economic models provide a poor description of the world we live in.  As I have said previously, I don’t agree with this conclusion – and we really need to ask what an economic model is, and why we are using it, to understand the scope of economics and the appropriateness of the assumptions.

In essence my view is that we use economic models to describe, and in some way explain, tendencies that exist (from induction) using assumptions about choice that satisfy two conditions:

  1. They are as weak and loosely binding as possible
  2. They are appealing in the sense that, when I ask myself about my actions I can deduce laws that guide them.  I could go a step further and say that we can set up “ideal experiments” in our minds, but I’ll leave that for now.

This is all well and good.  But then someone will say “what about habit formation“.  This is an important issue, people obviously develop habits and these habits bind and constrain behaviour.

In fact, I would go as far as to say that habits, and the formation of habits, provide the key to tying together a lot of different strands in experiments and behavioural economics – and that an understanding of habits and habit formation is an important part of improving economists way to describe the world and give advice.

So how do we “describe habits”?

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jamesz

Politics and cost-benefit analysis

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Brian Rudman in the Herald, discusses the cost-benefit analyses of major infrastructure investment that are required by Treasury guidelines:

I’ve come to the conclusion that the main beneficiaries of the big events politicians subsidise at our expense are the cost-benefit analysts hired to justify the expenditure in the first place.
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The cynical take on the process is that the whole cost-benefit palaver was introduced by politicians to put a veneer of neutrality on the decision-making on pet projects.
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That doesn’t worry me that much [but if] politicians … are going to support certain events and projects, despite the evidence of the cost-benefit analyses, why is so much public money wasted commissioning these expensive reports?

I’m a bit torn on the subject of CBAs of major projects. On the one hand, I think they should be extremely useful for informing political decisions. On the other hand, there’s plenty of evidence that politicians don’t pay any attention to them.
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jamesz

Unbelievably exciting results!

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Chris Dillow, via Eric:

…even intelligent and numerate people are quick to misperceive randomness and to pay for an expertise that doesn’t exist; the subjects included students of sciences, engineering and accounting.

Which reminded me of Andrew Gelman’s recent post about results in headline academic journals such as Science and Nature. He quotes Sanjay Srivastava saying:

As long as a journal pursues a strategy of publishing “wow” studies, it will inevitably contain more unreplicable findings and unsupportable conclusions than equally rigorous but more ‘boring’ journals. Groundbreaking will always be higher-risk. And definitive will be the territory of journals that publish meta-analyses and reviews.

We may all know that the implausible results that often lead headline journals are likely to be wrong, but it doesn’t seem to stop us citing them constantly!

jamesz

Why does the realism of assumptions matter?

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From Rogeberg on rational addiction:

Theories of rational addiction make assumptions concerning the choice rule, preferences and beliefs of people, and derive the resulting consumption plans. … Some economists claim support from the famous as-if methodology of Friedman 1953 … which explicitly identifies prediction as the only aim of “positive economics.”…[Such] explanations may prove excellent predictive devices as long as the empirical regularities they describe remain stable… [but] this defense comes at a cost: Since someone acting as-if he was rationally solving some decision problem would not behave optimally unless this was the actual decision problem he faced, assumptions matter when we turn to welfare analysis. Nor can as-if theories claim to explain in the sense of describing the mechanism or causal process underlying a phenomena, their aim is just to relate observable quantities in the simplest, most empirically successful way. To use a metaphor… an as-if theory of a car would be of no help to a mechanic if the car broke down.

The reference point for optimality depends upon the model you’re using. If it’s not a good causal explanation of the problem then it cannot tell you about the optimality of the agent’s decision.

It’s just another reminder that we need to be really careful when moving into the realm of welfare economics because it implies numerous additional assumptions that we don’t need elsewhere.

jamesz

Why economics helps everyone

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From the philosopher Jon Elster in a trenchant critique of Gary Becker’s approach to everything:

If Gary Becker didn’t exist, we would have to invent someone like him. For close to four decades he has been taking economic theory beyond its usual domain of applications, almost single-handedly creating the economics of discrimination, human capital theory, the economics of crime and punishment, and the economic theory of the family.
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Although I disagree sharply with much of it, it has raised the level of discussion enormously. Before Becker, most explanations of addiction did not involve choice at all, much less rational choice. By arguing that addiction is a form of rational behavior, Becker offers other scholars the choice between agreeing with him or trying to identify exactly where he goes wrong. Whatever option we take (I’m going to take the second), our understanding of addiction will be sharpened and focused.

Even if you don’t like the argument, the conclusions, or the framework, we can all agree that using a consistent analytical framework is a good thing!