Misbehavioral Law and Economics

Many legal rules—ranging from common-law contract doctrines to modern consumer protection regulations—are designed to protect individuals from their own mistakes. But scholars have neglected a core difficulty facing such policies: we humans are a motley bunch, and we are defined in part by our idiosyncrasies. As a result, one person’s mistake is another’s ideal choice. Making matters worse, it is hard to observe when a policy response misfires. If cognitive errors and psychological biases are as prevalent as current research suggests, then we have no reliable way of knowing consumers’ true preferences. So are we always faced with a dilemma, where any approach that helps one group of consumers must hurt another?

This Article suggests an approach to this impasse. The key is to distinguish two potential sources of individual preferences: subjective tastes and objective circumstances. For example, two day-traders betting in the stock market may differ along either dimension. Each may place a different subjective value on the thrill of gambling (taste), and a stock market loss may have different impacts on each trader’s objective financial health (circumstance). This distinction can guide policy. Consumers likely have better information on their subjective tastes, while third-party interventions can often make better use of objective circumstances in improving choices.

This approach underscores some of the limitations of the rising reliance on behavioral economics and psychology in legal scholarship and policy. This Article discusses how discerning tastes from circumstances could guide regulation of pressing issues including payday lending and investor protection.