Behavioural Economics (ECON30270)
Professor Liam Delaney
Behavioural Economics and the Effects on Retirement Planning Decision Making
Traditional economic theory suggests that people tend to make decisions by maximizing a utility function in which all of the relevant constraints and preferences are included and weighted appropriately (Levin, 2004). However, behavioural economists often are most interested in exploring how people make decisions in situations when they have incomplete information and decision biases (Levin, 2004). Previous research that has been conducted by Richard H. Thaler and Shlomo Benartzi supports the idea that in certain situations people tend to make decisions that are not economically rational, and in this report I will analyze how Thaler and Benartzi recognized that this was a major issue effecting employee retirement savings. This report will discuss the solution that they presented by specifically focusing on how the application of behavioural economic concepts shed light on how employee decision making tended to be economically irrational with regards to their retirement savings. This report focuses on how Thaler and Benartzi applied behavioural economic concepts when creating the Save More Tomorrow Program to help find a solution to issues faced with employee retirement savings.
Thaler and Benartzi designed the Save More Tomorrow program to help employees that were interested in saving more, but who were not committed enough to make those decisions on their own. This program consisted of four main parts, which each are highly influenced by behavioural economic concepts.
The first phase of the program consisted of employees being contacted regarding increasing the amount of their contribution rates (Thaler, 2004). In the designs of their program, Thaler and Benartzi stressed that during this initial phase, it was important for companies give employees ample notice of this opportunity before requiring a decision to be made (Thaler, 2004). The reasoning behind stressing this importance was due to hyperbolic discounting. Hyperbolic discounting relates to this stage of the program because it is the idea that people tend to favor immediate payoffs rather than later payoffs. However, this tendency is much stronger when payoffs are closer together in time. So, the strategy that Thaler and Benartzi created to emphasize that is it critical to approach employees as early as possible helped mitigate the hyperbolic discounting effect that employees would feel when deciding whether or not to take part in the program in the future (Thaler, 2004). So the idea of saving more tomorrow and in the future helped to weaken the hyperbolic discounting effect, ultimately leading them to preferring to join the program in the future as opposed to sticking with their current situation (Thaler, 2004). In contrast, if employees were not given much time to make the decision, they would most likely prefer their current situation as opposed to...