In recent years there has
been growing interest in the mixture of psychology and economics
that has come to be known as “behavioral economics.” As is true with many seemingly (as far as one knows or how
something appears) overnight
success stories, this one has been brewing (beginning to happen) for quite a
while. My first paper on the subject was published in 1980, hot on the heels (if you say that one event follows hard on
the heels of another or hot on the heels of another, you
mean that one happens very quickly or immediately after another) of Kahneman and Tversky’s (1979) (Daniel Kahneman and
Amos Tversky) blockbuster
(something
that is very successful) on
prospect (the term prospect referred to the
predictable results of a lottery) theory, and there were earlier
forerunners, most notably Simon (1955, 1957) and Katona (1951, 1953). The rise
of behavioral economics is sometimes characterized as a kind of paradigm-shifting (a basic change in ideas or methods)
revolution within economics, but I think that is a misreading (to understand or judge a person or situation wrongly) of the
history of economic thought. It would be more accurate (correct or true in every
detail, exact)
to say that the methodology of behavioral economics returns economic thinking
to the way it began, with Adam Smith
(was a
Scottish political economist and philosopher,1723-1790), and
continued through the time of Irving
Fisher (was
an American economist, statistician, inventor, and progressive social
campaigner. He was one of the earliest American neoclassical
economists, 1867-1947) and John Maynard Keynes (was a British economist, whose ideas fundamentally changed the
theory and practice of macroeconomics and the economic policies of governments,1883 –1946)
in the 1930s. In spite of this early tradition within the field, the behavioral
approach to economics met with considerable resistance within the profession
until relatively recently. In this essay
(a short piece of writing on
a particular subject that
is published in
a book, magazine, or newspaper) I begin by
documenting some of the historical precedents
(is
something that precedes, or comes before) for utilizing a
psychologically realistic depiction of the representative
agent (use
the term representative agent to refer to the typical decision-maker
of a certain type, for example, the typical consumer, or the typical firm ).
I then turn to a discussion of the many arguments that have been put forward (to offer an idea, opinion, reason etc., especially so
that people can discuss it
and make a decision) in favor of
retaining the idealized model of Homo
economicus (Homo
economicus is a model for human behavior) even in the face of
apparently contradictory evidence. I argue that such arguments have been refuted (to try to show that an idea or belief
is wrong), both theoretically and empirically (based on scientific experiments),
including in the realm (a particular area of knowledge) where we
might expect rationality to abound (to be present in large numbers or amounts): the financial markets (refers to a marketplace, where creation and
trading of financial assets, such as shares, debentures, bonds, derivatives,
currencies, etc. take place.). As such, it is time to move on to a more constructive approach (constructivism
is ‘an approach to learning that holds that people actively construct or make
their own knowledge and that reality is determined by the experiences of the
learner). On the theory side, the basic problem is that we are
relying on one theory to accomplish two rather different goals, namely to
characterize optimal behavior and to predict actual behavior. We should not
abandon the first type of theories as they are essential building blocks for
any kind of economic analysis, but we must augment them with additional descriptive theories (seek to
understand rationality by describing and capturing in statistical
terms the decisions that people make) that are derived from data
rather than axioms.
As for empirical (based on real experience or scientific experiments rather
than on theory) work, the
behavioral approach offers the opportunity to develop better models of economic
behavior by incorporating insights (a sudden clear understanding of
something or part of something, especially a complicated situation) from other
social science disciplines. To illustrate this more constructive approach, I
focus on one strong
1578 THE AMERICAN ECONOMIC REVIEW JULY 2016
prediction (a statement about what you think is going to
happen, or the act of making this statement) made by the traditional
model, namely that there is a set of factors that will have no effect on
economic behavior. I refer to these as supposedly irrelevant (not useful or not relating to a particular situation)
factors or SIFs. Contrary to the
predictions of traditional theory, SIFs matter; in fact, in some situations the
single most important determinant (something that
controls or decides how something else will develop or
what result it will
have) of behavior is a SIF. Finally, I turn to the future. Spoiler alert (is the situation when important
detail of the plot development is about to be revealed): I predict
that behavioral economics will eventually disappear.
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