A Framework for Behavioral Welfare Analysis

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The PI will incorporate recent research results from behavioral economics into the theory of welfare economics. Interest in psychological approaches to economic questions has grown in recent years, stimulated largely by accumulating evidence that the standard economic model of consumer decision-making may provide an inadequate description of human behavior. "Behavioral" economic theories that incorporate non-standard components (motivated by psychological evidence) are increasingly finding their way into policy evaluation, which inevitably involves what economists call "welfare analysis" (that is, assessments of well-being). Yet these new theories fundamentally challenge our ability to formulate appropriate criteria for judging whether outcomes are "good" or "bad." If, contrary to the traditional assumption in economics, an individual's choices do not reflect coherent preferences, how can those choices provide economists with a basis for judging whether one outcome is better than another?This project develops, applies, and refines a unified framework for policy evaluation that encompasses the new generation of behavioral economic theories. The framework developed here is a natural extension of standard welfare economics. The standard approach is based on choice. In its simplest form, it advises a policy maker to respect the choices an individual would make for himself. The guiding principle behind that approach is an extension of the libertarian deference to freedom of choice, which takes the view that it is better to give a person the thing he would choose for himself rather than something that someone else would choose for him. The central premise of this project is that the same principle remains applicable even when people behave in ways that are inconsistent with standard economic assumptions. Although the guidance provided by people's choices may be ambiguous in some circumstances, it is typically unambiguous in others, and this partially ambiguous guidance can provide a foundation for rigorous policy evaluation. The project develops a general framework for policy evaluation and explores its implications for particular behavioral theories. It also reexamines an assortment of public policies, employing generalizations of the standard tools that economists conventionally use when evaluating the desirability of public policies. The broader impact of this work will follow directly from its focus on developing appropriate criteria for evaluating public policies. Previous studies that have employed non-standard behavioral models in the context of public policy analysis have generally relied on ad hoc criteria for assessing the relative desirability of different outcomes. This project will revisit many of those policy issues, such as the design of capital income taxes and social security, to identify conclusions that are rigorously justified based on the application of the new framework. In addition, this work enables greater integration of economics, psychology, and neuroscience. Specifically, it allows economists to conduct rigorous welfare analysis using literally any model of behavior, including ones imported from other fields, regardless of whether those models depict behavior as reflecting optimization.