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Behavioral Law & Economics Christina Maria Markowski. I. What is behavioral law & economics („BLE“)?. concerned about humans behavior (how people act/react) effect of different norms consistent tools and approaches to impact human behavior explicit models of legally relevant behaviour
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policy makers rely on mere intuitions about human
behavior to guide their decisions => systematic errors + contradiction in the law)
Traditional law & economics:
- models based on assumptions
- strictly rational actor
- self interest seeking
BLE attempts to improve the predictive power of law & economics!
II. Bounded Rationality: Psychology of Judgment and Decision Making
How do people form judgments and what impacts their decision?
Kahneman: System I: operates automatically, quickly, with little effort an no voluntary control
System II: allocates attention to the effortful mental activity that is demanded including complex computation
- impossible to process every decision
- don’t know all variables
- use short cuts, rules of thumb, heuristics
Human beings are bounded rational= face limited cognitive resources and are affected by emotions and motivations!
Studying the psychology of JDM in 2 ways
How do people assess the probability of uncertain events?
Some of the major heuristics:
=> Bias: neglect base rate (70 engineers, 30 lawyers)
insensitivity of predictability (description of a company)
illusion of validity (information matching stereotype)
=> Legal Impl.: character evidence of a defendant
=> Bias: over-/underestimation (some events impact availability but not prob.)
=>Legal Impl.: lower crime rates in cities/ fine for wrong parking
deterrence: (i) increase magnitude or (ii) prob. of sanction
=> Bias: affect-rich outcomes yield significant overweighting of small probabilities
=>Legal Impl.: risk regulation for nuclear power station (excessive demand, inefficent high regulation)
Some other effects in the process of decision making:
8 x 7 x 6 x 5 x 4 x 3 x 2 x 1 = ? (2250)
1 x 2 x 3 x 4 x 5 x 6 x 7 x 8 = ? (512; 40.320)
=> Legal Impl: judges effected by the plaintiff\'s damages demanded as anchor
Why?update information automatically and employ it when having to make judgment (instead of ex ante)
=> Legal Impl: judges overestimate foreseeability after accident occurred tortfeaser to often negligent, excessive level of precaution
=> Bias: self serving bias (eg.: litigation 50:50 chance to win)
optimistic bias (own prob. is higher/lower compared to others)
2. Preferences = peoples choice under uncertainty
A. Imagine that the U.S. is preparing for the outbreak of an unusual disease, which is expected to kill 600 people. Two alternative programs to combat the disease have been proposed.
The consequences of the two programs are as follows:
B. Imagine that the U.S. is preparing for the outbreak of an unusual disease, where in the best case all 600 people will be saved.
The two programs to combat:
Rational choices depend on value, preference and risk attitude but not on framing!
Utility function of a risk averse person:
Traditional law and economics => people are risk averse (concave function)
BLE – Kahneman & Tversky: Prospect Theory (1984, American Psychologist)
Traditional Law & Economics:
The Coase Theorem posits that theinitial allocation does not affect final allocation if transaction costs sufficiently low and market participants are fully informed
Behavioral Law & Economics:
(empirical assessment by D. Kahneman, J. Knetsch, R. Thaler)
Experiment A: “token” with assigned value => WTA = WTP
Experiment B: Cornell University coffee mugs => WTA > WTP
endowment effect = “refusal to give up an entitlement one holds due to disutility of giving up something”
Implication for L&E: unsettles bases for normative economic analysis
cost-benefit analysis can not be based on WTP
(function of default rule)
Possible Solution: instead of parties joint welfare consider third party effects
asking which rule deserves greater deference
(eg.: opt in or opt out of a saving plan)
1. Bounded Willpower (people want something different to what they do)
2. Bounded Self-Interest (do not necessarily want to max. own wealth)
Implicit bias in people’s perception of racial and other group members (conventionally not grouped with other forms of bounded rationality)
Consider: A high income individual faces a 2% probability of incurring tort liability for an accident, thereby facing the risk of 500.000 € extra payment in damages or having to pay 10.000 € tax (risk neutral).
(i) money redistributed by legal rule or
(ii) via tax system
(any distributional issue can be achieved at lower cost through tax system than distributive legal rules)
- depending on an uncertain event (party to lawsuit)
optimism bias: underestimate probability of being hold liable
perceived cost lower than expected cost of 10.000 €
Consider: Under US Law rules require parties to disclose all relevant information
convergence of parties expectation
facilitates out of court settlements (more accurate)
more information – more prone to bias
experiment: likely outcome at trial – third party/plaintiff/defendant
more information might lead to divergence
Kahneman’spathbreaking work also provides insights for lawyers:
make sure they answer the right question
Ben: envious; stubborn; critical; impulsive; industrious; intelligent.