Lecture: Nudges and Everyday Decisions

Try listening first, then use the text to check what you heard. Audio uses a computer-generated voice.

Good morning, everyone. Last week we looked at the traditional economic model, which assumes that people make rational decisions based on complete information. Today I want to complicate that picture, because in real life, people rarely behave the way the model predicts. Let's start with a simple example: retirement savings. For decades, many employers offered pension plans that workers had to actively join — you had to fill in a form. Participation was often surprisingly low, even though joining was clearly in people's interest. Then some companies tried something different: they enrolled everyone automatically, and workers could leave the plan if they wanted to. Participation rose dramatically, in some studies from under half to more than ninety percent. Nothing about the plan itself had changed — only the default option. This is what researchers call a nudge: a change in how choices are presented that influences behaviour without forbidding any option or significantly changing incentives. A second principle is loss aversion. Put simply, losing a hundred dollars feels considerably worse than gaining a hundred dollars feels good. This helps explain why a charge described as a penalty for paying late often changes behaviour more than a discount for paying early, even when the amounts are identical. Now, I should add a note of caution. Nudges have become fashionable with governments, partly because they're cheap. But critics raise two important points. First, some large-scale reviews suggest that the average effect of nudges is smaller than early studies claimed — the dramatic results tend to get published, the modest ones don't. Second, there's an ethical question: if a government designs choices to steer you, who decides what's good for you? Personally, I think nudges are a useful tool, but they're not a substitute for policy. Automatic enrolment helps people save, but it doesn't help someone whose wages are too low to save anything at all. For next week, please read chapter four and come prepared to discuss one nudge you've encountered in your own life.