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Behavioral law and economics
1. A little history2. Williams v. Walker-Thomas3. Rational choice versus behavioral economics4. Case study: obeying contracts5. Policy implications6. Behavioral economics and the common law
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A little history: contract law and theoryYear Society Academia
19th century One-on-one bargaining Dark ages
1900-1940s Rise of mass markets Doctrinal scholarship (“Langdellian formalism”)
1950s-1960s Era of mass markets; form contracts; consumer protection movement
“Law and society”: simple qualitative empirical scholarship; breakdown of formalism
1970s-1980s Law and economics: simple formal models of doctrines (damages, offer/acceptance, and so on); heyday of free-market thought1990s Rise of Internet contracting; software
licensing agreements2000-present Social media; privacy concerns;
financial crisis of 2007-2008Behavioral law and economics; quantitative empiricism; increasing skepticism about markets
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Williams v. Walker-Thomas
• Facts• Buyer buys goods on installment. She makes a number of payments over several
years, and then misses one payment. Seller seeks to repossess all the goods—including the earliest goods she bought—under the cross-collateral clause:
"the amount of each periodical installment payment to be made by [purchaser] to the Company under this present lease shall be inclusive of and not in addition to the amount of each installment payment to be made by [purchaser] under such prior leases, bills or accounts; and all payments now and hereafter made by [purchaser] shall be credited pro rata on all outstanding leases, bills and accounts due the Company by [purchaser] at the time each such payment is made."
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• Issue• Is the cross-collateral clause unconscionable?
• Holding: yes• Lack of clarity• Lack of choice• Unequal bargaining power
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Normal balance
Item Price Payment Balance Owned?
Bed $400 $100 $300 Yes
Lamp $50 $100 $250 Yes
Chair $150 $100 $300 No
TV $300 $100 $500 No
Rug $100 $100 $500 No
Total $1,000 $500 $500
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Cross-collateral clause
Item Price Payment Balance on item Owned?
Bed $400 $100 $200 No
Lamp $50 $100 $25 No
Chair $150 $100 $75 No
TV $300 $100 $150 No
Rug $100 $100 $50 No
Total $1,000 $500 $500
Williams has paid $500 on $1,000 in debt; so 50% payments are applied on the balances of all the items
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Williams compared to Henningsen
• The reasoning in Williams is similar to that of Henningsen, but Williams highlights the following facts:• The buyer, Williams, is poor and on welfare• The seller knew this, and was in the business of selling goods to such people• Williams was probably not well educated• The transaction involved credit, and the controversial term was a credit term• Yet she had experience in this market
• Was Williams’ purchase rational? In her self-interest?• Did she understand the clause?• Was she wise to risk losing all her furniture in order to buy some more?• Was the seller catering to her needs or exploiting her?
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Behavioral economics
• While buyers try to maximize their utility, they make predictable mistakes• Affected by irrelevant information (“availability,” “representativeness”)• Discount the future too much or inconsistently (“optimism”)• Afflicted by inertia; do not “bargain around” (passive)
• Williams might have:• Underestimated costs because presented as monthly rents• Been too optimistic about her future expenses• Been unwilling to try to contract around the cross-collateral clause
• Seller might have deliberately exploited these behavioral biases
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Other examples (Bar-Gill)
• Rebates• Table costs $100• Competitive market with rational consumers: price = $100• Consider strategy of raising price to $110 with mail-in rebate of $20• Seller can attract customers by advertising post-rebate price of $90, while
expecting that more than 50 percent of customers will neglect to submit rebate request (in fact, few will request rebate)• Behavioral bias: optimism (about requesting rebate)• Inefficiency: people buy tables they don’t want
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• Credit card late fees• Consumers focus on interest rates• Competition results in competitive interest rates• Some credit card issuers offer lower interest rates along with high late fees• Consumers underestimate probability of being late• Bias: optimism (about paying credit card bill on time)• Distortion: people borrow too much
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• Health clubs• Suppose health club incurs cost of $10 per visit by customer• Health clubs can sell one-day passes for $10• But people overestimate how often they will use health in a year
• Suppose people think they will visit club once per week (52 times)• In fact, people go only once per month (12 times)• So people think one-day passes will cost $520/year; in fact, the health club incurs only
$120/year in costs• So health club can offer one-year pass for (say) $250• People buy one-year passes when they would be better off with per-visit passes• Bias: optimism• Inefficiency: people will use health clubs too rarely
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• Investment• People (probably) save too little• Most people do not understand compounding interest• They do not properly diversify their assets
• Home-country bias in stock market• Employer bias in stock market• Influenced by choice of funds that are presented to them• Do not rebalance every year
• Trade too often (“churning”)• Try to pick stocks• Buy too much insurance
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Traditional economic response
• Mistakes “wash out” or are trivial• Williams has a lot of experience in consumer markets• She could have benefited from lower prices• People learn from their mistakes• People pay institutions for advice (e.g., Consumer Reports)
• Market competition corrects for mistakes• Walker-Thomas’ competitors will offer Williams a better deal• But not clear that competitors can do this
• Rebate example: Rival sellers may offer identical rebates rather than advertise true price. Distortion persists in competitive market.
• Walker-Thomas might worry that it will lose sophisticated customers
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Case study: Eigen
• Eigen wants to investigate whether the “framing” of contractual obligations affects whether people comply with them• In other words, are people more likely to comply with contracts if they
understand the obligation to be moral rather than legal, social, or instrumental?• Why should we care?
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• How is Eigen’s approach different from Marotta-Wurgler’s?• Marotta-Wurgler finds data from the real world and analyzes it. She looks at
how actual companies design their license agreements.• Eigen conducts an “experiment.” He asks people to fill out a survey on the
Internet.• What are the advantages and disadvantages of each approach?
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How does Eigen design his survey?
• He solicits 1,400 participants by offering them a DVD in return for their participation• He designs a Web-based survey form for them to fill out. 480
questions, each on a separate Web page. Limited navigation capacity.• He carefully monitors their behavior on the Web
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• What does “framing” mean?• Moral: you made a binding promise to complete the survey• Legal: you are contractually bound to complete the survey• Social: nearly everyone completed the survey• Instrumental: you need to complete the survey in order to receive the DVD
• Respondents were put in different groups, and:• Given a moral, legal, social, or instrumental reason to complete the survey
once they agreed to begin it• Prompted with a moral, legal, social, or instrumental reason to complete the
survey if they attempted to stop before they finished it
• From an economic standpoint, should the framing matter?
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Results
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Implications and questions
• People are more likely to keep a promise for moral or social reasons than for legal or instrumental reasons• This seems to be inconsistent with standard economic models
• But note models of “herd behavior”
• However, are these effects strong enough to matter in the real world?• Is there a problem of selection bias?• Are they of any importance for law?
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Policy responses
• Problem: clauses like cross-collateral clauses may be good for some people and bad for others, depending on their conditions• A prohibition on cross-collateral clauses hurts people who understand and
benefit from them.• Permitting cross-collateral clauses hurts people who don’t understand or
benefit from them.• What to do?
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Nudge-style responses
• Disclosure: require Sellers to disclose• Not much evidence this works; we’ll discuss next class• Bar-Gill: require Sellers to disclose use patterns to consumers
• For example, health clubs should tell customers they won’t use the club very much
• Create a default rule that favors (vulnerable) buyers• For example: the law could provide that balances are paid off normally unless
the buyer agrees to opt out• Will this work?
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Does the common law reflect economic rationality or behavioral principles?• Common law is often interpreted as reflecting economic rationality.
Relatively limited protections for contract parties• But exploitation of people’s predictable mistakes can be interpreted
as a kind of “manipulation,” which is barred by various doctrines• Fraud• Duty to disclose• Good faith and fair dealing• Undue influence and duress
