The behavioural economics

Context:

The 2017 Economics Nobel was awarded to Richard H. Thaler, University of Chicago, IL, USA “for his contributions to behavioral economics”

Behavioral economics, along with the related sub-field behavioral finance, studies the effects of psychological, social, cognitive, and emotional factors on the economic decisions of individuals and institutions and the consequences for market prices, returns, and resource allocation, although not always that narrowly but also more generally, of the impact of different kinds of behavior, in different environments of varying experimental values

Behavioral economics experiments:

  • Richard Thaler once got together a group of students to take part in what is now recognized as a landmark experiment. He asked students to share an endowment of $20 with an anonymous classmate each. The students who had been given the money had to make a choice: either split the endowment equally with the anonymous partner, or keep $18 while giving the other student only $2.
  • Standard economics would predict that a rational student would choose the second option, especially since the anonymity ensures there is no threat of reputation. However, a majority of the students who took part in the experiment chose to share the money equally.
  • The results of this dictator game—as well as a similar experiment that goes by the name of the ultimatum game—shows thatpeople value fairness in their economic lives. Thaler wrote about these results in a classic paper on fairness that was published in 1986. His results have been replicated in thousands of experiments in subsequent years.

Highlights of the experiment:

  • Thaler is at the forefront of a broad movement to build economics on more reasonable assumptions about human behaviour.
  • The dictator game shows that humans value fairness in their economic interactions.
  • Thaler has also thrown fresh light on our limited rationality, our inability to stick to goals because of the lack of self-discipline, and the trouble we have in discounting the future.
  • His doctoral work on how to statistically value human life has survived the initial scepticism of his thesis adviser. His ideas on the endowment effect and mental accounting have now filtered into public discourse.
  • Behavioural economists are one part of the broader project to reframe human motivation in economics. A short detour into the history of modern economic thought can throw the spotlight on a bigger set of economic theorists, in part to challenge the popular caricature that economists do not understand the nuances of human behaviour.

Criticisms:

  • Does the limited rationality of individuals necessarily mean that aggregate markets are irrational?
  • Do human beings behave in real life as they do in controlled experiments? For example, will a man who finds a wad of currency notes on the pavement begin to share it with the people around him in the interests of fairness?

Conclusion:

There is no doubt that behavioural economics poses a powerful—and welcome—challenge within economics. Thaler is undoubtedly one of the giants in this field, and his theoretical work is as important as the books through which he has popularized his ideas. Behavioural economics should be seen as one part of a broader attempt to base economic thinking on more nuanced assumptions of human behaviour.

Economics took an important turn some four decades ago when models of the macroeconomy began to be built on assumptions about individual human behaviour—or micro-foundations. The first such models assumed the representative human being was perfectly rational, but behavioural economics poses a powerful challenge to that assumption at the level of individual decision-making. The challenge is to integrate its insights into mainstream models that look at the broader economy.

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