Standard Efficiency-based Rationales(cont...)

Non-standard Economic Rationales: Behavioral Economics

A new paradigm of behavioral economics is slowly emerging, with a realization that the traditional concept of the sovereign, rational, and always well-informed consumer may not in all instances help in understanding and predicting people’s decisions and behavior. It holds that there are situations in which people act with bounded rationality.

One important feature is the idea of “time-inconsistent preferences,” which results in individuals accepting instant gratification at the expense of their long-term best interests. For example, a smoker asked today to stop smoking immediately will probably answer no, but might agree, now, to stop smoking in one year.

One year from now, if asked again to quit smoking, he or she might prefer to continue smoking rather than adhere to the previous commitment to quit. As time progresses, each

future date comes into the present and the preference for immediate enjoyment will prevail.

In other words, the present “self” of the individual disagrees with his or her future “self”.

Since the decisions of the present self do not take into account the consequences of that self’s actions on the future self, it imposes a type of externality on the future self. The United States provides some empirical evidence on time-inconsistent preferences. Eight out of 10 smokers express the desire to stop, but many fewer actually do. Gruber (2002) reported that over 80 percent of smokers try to quit annually, the average smoker tries to quit every eight months, and 54 percent of serious cessation attempts fail within a week.

Time-inconsistent preferences may justify an intervention (e.g., a tax) to induce people to do what they may want to but are unable to do alone. The size of the internal costs could suggest the size of an optimal tax, in addition to any tax that might be justified by the presence of external costs. Gruber 2002) estimated that external costs would convert to a tax of US$0.40 per pack of cigarettes or less— much less than the US$35 internal costs.