This are the slides for an introductory lecture on behavioural law and economics I gave as part of the economic analysis of law unit at the University of Bristol Law School in March 2017.

1. Law and economics 2.0
Dr Albert Sanchez-Graells
University of Bristol Law School
6 March 2017

2. Agenda
• This lecture provides an introduction to the critique of traditional
economic analysis of law that has resulted from developments in
behavioural economics – ie ‘law and economics 2.0’
• The main focus will be on the behavioural challenge to the rationality
assumption (homo economicus) and the impact it has on the
theorisation of law from an economic perspective

3. Short recap of the homo economicus
The neoclassical economic
analysis of law with which we
have engaged most of the time is
based on rational choice theory
This implies:
• Rationality, perfect information &
risk neutrality*
• Individuals are rational maximisers of
their utility (within their constraints)

4. Short recap of the homo economicus
• Becker offers a typical account of those principles: “[A]ll human
behavior can be viewed as involving participants who [1] maximize
their utility [2] from a stable set of preferences and [3] accumulate an
optimal amount of information and other inputs in a variety of
markets.” [The Economic Approach to Human Behavior (1976) 14]
• Thaler & Mullainathan spell out the implications “The standard
economic model of human behavior includes three unrealistic traits—
unbounded rationality, unbounded willpower, and unbounded
selfishness” [“Behavioral Economics” in The Concise Encyclopeida of
Economics, 2nd edn (2008)]

5. How do we (think that we) think?
• There is growing popularity and
acceptance of Kahneman’s dual
process theory:
(1) intuitive & automatic thinking
(2) reflective & rational thinking
[Thinking Fast and Slow (2011)]
• Rational choice theory / homo
economicus is easier to reconcile
with system 2, but fundamen-
tally incompatible w/ system 1

6. Behavioural challenges to homo economicus
• Economists had been doubting the assumptions underlying rational
choice theory for a long time [notably, Thaler’s Quasi Rational
Economics (1991)]
• Jolls, Sunstein & Thaler (1998) provided a strong criticism of the
theory of rational choice and its application to law and economics on
the basis that individuals are affected by
• Bounded rationality
• Bounded willpower (or self-control)
• Bounded self-interest

7. Bounded rationality
• “Bounded rationality … refers to the obvious fact that human
cognitive abilities are not infinite. We have limited computational
skills and seriously flawed memories”
• “The departures from the standard model can be divided into two
categories: judgment and decision-making. Actual judgments show
systematic departures from models of unbiased forecasts, and actual
decisions often violate the axioms of expected utility theory.”
(Jolls, Sunstein & Thaler, [1477]).

8. Bounded willpower
• “… human beings often take actions that they know to be in conflict
with their own long-term interests.”
• “… the demand for and supply of law may reflect people’s
understanding of their own (or others’) bounded willpower”
(Jolls, Sunstein & Thaler, [1479]).

9. Bounded self-interest
• “the term bounded self-interest [is used] to refer to an important fact
about the utility function of most people: They care, or act as if they
care, about others, even strangers, in some circumstances. (Thus, we
are not questioning here the idea of utility maximization, but rather
the common assumptions about what that entails.)”
• “… the agents in a behavioral economic model are both nicer and
(when they are not treated fairly) more spiteful than the agents
postulated by neoclassical theory.”
(Jolls, Sunstein & Thaler, [1479]).

10. Core behavioural law & economics (2.0)
• Popularised by Thaler & Sunstein (2008)
[choice architecture; libertarian paternalism]
• Biases and blunders
• Rules of thumb: anchoring, availability &
representativeness
• Optimism & overconfidence
• Loss aversion
• Status quo bias
• Framing
• Mindless choosing & self-control
• Herd behaviour
• Conformity, spotlight effect, social contagion

11. Is that all?
Psychologists and
sociologists could
surely expand the list
of ways in which
individuals
(sometimes/regularly/
always?) deviate from
rational thinking
Where to stop?

12. Core behavioural law & economics (2.0)
• Currently, there is a consolidation of the issues around bounded
rationality, willpower and self-control that behavioural law &
economics covers [eg Englerth, in Towfigh & Petersen (2015)]
• Bounded rationality
• Judgment: (a) Heuristics (availability, representativeness); (b) Hindsight bias;
(c) Excessive optimism and overconfidence bias (wishful thinking, self-serving bias)
• Decisions: (a) anchoring; (b) extremeness aversion; (c) prospect theory (endowment
effects, loss aversion and status quo bias); (d) framing
• Bounded willpower or self-control
• Reversal of preferences over time; ‘present bias’ (or hyperbolic discounting)
• Bounded self-interest
• Social preferences (norms of fairness, principle of mutuality)

13. Behavioural analysis on the rise
• Now probably more than ever,
in particular regarding
• Financial crisis (2008)
[Taleb, The Black Swan: The Impact of the Highly
Improbable (2008)]
• Political developments (2016)
• Brexit
• Trump’s election
• ‘Fake news’
[Kolbert, ‘Why Facts Don’t Change Our Minds’, New
Yorker, 27 Feb 2017]

14. Not only an academic issue
• Created in 2010
• Policy work aimed at
introducing behavioural
approaches to policy-
making
• Applying Behavioural
Insights: Simple Ways to
Improve Health
Outcomes (2016)
• Better choices: better
deals (2011)

15. So what is law & econ 2.0 trying to do?
• As Thaler (2015) has put it
“We don’t have to stop inventing abstract models
that describe the behaviour of imaginary Econs.
We do, however, have to stop assuming that
those models are accurate descriptions of
behavior, and stop basing policy decisions on such
flawed analyses. And we have to start paying
attention to those supposedly irrelevant factors”
[that determine the behaviour of Humans even if
they would not alter the behaviour of Econs]

16. What does this all mean for (neoclassic)
economic analysis of law?

17. Some counter-criticisms to law & econ 2.0
• Demsetz has provided a counter-criticism to the behavioural
challenge: “The model of human behavior used in economics is a tool
applied to gain an understanding of how the decentralization puzzle is
resolved, and, like any tool, it is specialized to its primary task. It
emphasizes some aspects of human behavior while repressing others”
[“Where Economic Man Dwells”, in From Economic Man to Economic
System (2011), first ideas from 1996]
• Posner similarly stressed that “… in theory-making, descriptive
accuracy is purchased at a price, the price being loss of predictive
power” (“Rational Choice, Behavioural Economics and the Law”
(1998) 50 Stanford Law Review 1551, 1559)

18. Some counter-criticisms law & econ 2.0
• Posner provided a comment/reply to Jolls, Sunstein & Thaler (1998)
• Characterises rational choice as dependent on hyperrationality and dismisses
previous efforts to enrich rational choice theory as ad hoc
• Behavioural economics is antitheoretical
• On bounded rationality: instrumental thinking is not irrational and
preferences may be irrational, but acts on those preferences not
• On bounded willpower (or weakness of will): hyperbolic discounting can be
explained in terms of information costs; ‘multiple selves’ approach (*)
• On bounded self-interest: altruism as interdependent utilities
• Paper is rather a contribution to the psychological analysis of law than to the
economic analysis of law
• Discusses evolutionary biology as part of the economic endeavour (*)

19. Some counter-criticisms law & econ 2.0
• Posner continues to stress that “Rational maximisation should not be
confused with conscious calculation … Behaviour is rational when it
conforms to the model of rational choice, whatever the state of mind
of the chooser … Nor is rationality omniscience. Information is costly,
and often the costs are prohibitive, especially when the information
one would like to have concerns the future. Rational choice theory
accepts that people’s ability to process information is limited—there
are costs not only of obtaining information but also of absorbing and
using it” [Economic Analysis of Law, 9th edn (2014)]
• Does this allow for a reconciliation with the Coase theorem?

20. Overview of sticky disagreements
• Thaler has provided a succinct account
of the counter-criticisms and sticky
points of disagreement between
neoclassic and behavioural economists
• As if (marginal theory)
• Incentives (ie high-stakes)
• Learning (ie repeated games)
• Markets (invisible hand)

21. Additional issues surrounding nudging
• As defined by Thaler & Sunstein (2008: 6), a nudge is “… any aspect of
the choice architecture that alters people’s behaviour in a predictable
way without forbidding any options or significantly changing their
economic incentives”.
• The normative aspect of behavioural law & economics as enshrined
by Thaler & Sunstein (libertarian paternalism) has raised a number of
issues that bring the discussion closer to jurisprudence (liberty)
• Concerning potential manipulation of choice and the lack of neutrality of
choice architecture: transparent and non-transparent nudges [see eg Hansen
& Jespersen (2013)]; definitional issues [see eg Hansen (2016)]
• Concerning the need for a more sociological approach to these issues (homo
oeconomicus culturalis) [eg Frerichs (2011)]