What is Behavioral Economics?

Coverage of Behavioral and Experimental Economics in Undergraduate Microeconomics Textbooks

Experimental and behavioral economics are well established branches in the economic science. This essay presents and discusses some results and behavioral regularities from these fields which are of potential importance for public policy. After a brief introduction of what experimental and behavioral economics is, some behavioral regularities as presentation and framing effects, pro-social behavior, and reciprocity are introduced and it is reported how they interact with prominent trading institutions, taxation, and social and individual well-being. Throughout some implications for public policy are discussed.

ABSTRACTThis article uses George Soros’ theory of boom–bust cycles to argue that mainstream economics, as built on Samuelson’s Foundations, followed a similar boom-bust cycle. It underwent a reflexive, positive feedback pattern of development before 1980 followed by a reflexive, negative feedback pattern of development after 1980, making it a science bubble. The positive feedback pattern was associated with the ‘misconception’ that when economics is framed as a natural science as per Samuelson, it improves its descriptive capacities as a science; the negative feedback pattern was associated with increasing recognition that this was a ‘misconception’ and the emergence of mainstream economics’ performative ambition—the idea that economics aims to construct the world in its own image rather than describe it. The article discusses how this latter aim is embodied in later game theory, ‘new’ behavioral economics and mechanism-design theory. Yet the vision of economics as a performative science is inconsistent with Samuelson’s natural science model of economics. Thus, mainstream economics turns out to be a science bubble much like many other mistaken, superseded research programs in the history of science.

During the last 30 years a large and wide-ranging literature has emerged on the economic analysis of politics or, as it is more commonly called, public choice. Mainstream public economics has to some extent taken heed of some of this development. Most public finance books now have an obligatory chapter on public choice. Public choice, however, has not subsumed the entire field of public economics; the lessons tend to be kept to one side. Yet at the very least the central propositions now receive some recognition. This has not been the case with the theoretical developments which have occurred in behavioral economics. One would search the public economics textbooks in vain for any reference to Simon’s Nobel Prize-winning work on behavioral economics. It is not altogether clear that neoclassical economists should be solely blamed for ignoring these developments. Little has been written on the intersection between behavioral economics and public economics. Aside from a few papers on the intersection between welfare economics and behavioral economics (Rosser, 1977; Steedman and Krause, 1986) and an appendix in Little’s (1957) critical book on welfare economics — in which he analyzes the Edgeworth box from the kind of standpoint that has found favor among behavioral economists — there is very little on which to work.

This article rests on establishing a unique standpoint that life insurance products (unlike other financial assets) are purchased for protection, not as an investment for return. This aims at identifying the most suitable theoretical framework to study the life insurance market and to suggest appropriate tools of analysis. Economic and financial theories starting from neo-classical economics, going up to behavioural economics (BE) have been studied vis-à-vis life insurance markets. A distinction has been drawn between BE and behavioural finance (BF). Accordingly, neo-classical economics, standard theory of finance and BF have been found to be inappropriate to understand life insurance as a market. The main theoretical edifice of BE, with a blend of transaction-cost approach and information theoretic approach, is argued to be the right theoretical framework to study the life insurance market, given the idiosyncrasies involved. A novel attempt has been made to create a ‘construct’ to depict how the BE framework is most relevant. It is hypothesised that bounded rationality is adversely influenced by emotions, search costs, intermediaries and socio-psychological influences, to embed behavioural biases and heuristics into life insurance purchase decisions. Combinedly, this leads to demand and supply distortions that create an incomplete market. To test this framework, it has been suggested that Heuristic z-test; Murthy’s Index of Rank Dominance (MIrd & MRird); and logistic regression, be harnessed. These tools would help in measuring market inefficiency and underperformance. Policymakers, the regulator, insurers and buyers alike would benefit from a better understanding of the market.

This paper was published in 1999, a few years before Daniel Kahneman and Vernon Smith won the 2002 Nobel Prize in economics. Many of us in the field of behavioral economics suspected that a Nobel Prize was in the works for our field, and we worried that it would be jointly conferred on behavioral economics and experimental economics by people who couldn’t tell the difference between them. The paper starts by pointing out that behavioral economics and experimental economics are entirely different enterprises. Behavioral economics is the application of insights from psychology (and sometimes other disciplines) to economics. Experimental economics is the application of experimental methods to economics.

Focus on Authors

ABSTRACTThe concept of Methodenstreits is used to analyse the relationship between behavioral and mainstream economics. A Methodenstreit is understood by the authors as a dispute between the more abstract and the less abstract canons of the economic science. It undergoes several necessary stages: discovery of a new research instrument, an exaggerated debate between the canons, and mutual enrichement after the debate. The article reviews the following Methodenstreits: empirical investigations of Hall, Hitch, and Lester vs neoclassical theory of the firm (the ‘full cost controversy’ and the ‘marginalist controversy’); Katona’s consumer research vs Keynesian macroeconomics; Simon’s bounded rationality approach vs neoclassical maximization; and experiments of Allais and others vs expected utility theory.

Economics is by no means an empty box. For example, it offers what is possibly the only general law of behaviour in the social sciences, namely that agents react to incentives. Over the past two decades or so, at the micro level, the level of individual agent decision making, the discipline has made progress. Developments in the econometric theory of the analysis of large longitudinal data bases and the rise of behavioural and experimental economics have made the discipline much more empirical. However, at the macro level, economics has, if anything, gone backwards. The main intellectual effort since the 1980s has been to import the concept of equilibrium into macroeconomics. It is no surprise that policymakers during the financial crisis of the late 2000s found the mainstream economic models to be of little or no help at all. In the 1950s, there was an active debate about the computational limits which agents faced when making decisions. The polymath Nobel Laureate Herbert Simon was prominent in arguing that the rational model of choice, the core model of economic theory, was not realistic in many situations because of these limits. Even after the event, it may not be possible to determine what the optimal decision would have been at any given time. The world is in general too complex. Mainstream economics gradually lost sight of this fundamental challenge to one of its key assumptions. The rise of cyber society and Big Data mean that Simon’s challenge is more relevant than ever. Looking to the future, new models of ‘rational’ agent behaviour are required which are better suited to the cyber society of the twenty-first century. Key areas of research include: agent decision making rules; heuristics to identify decision types in any given context; network percolation of imitation, incentives, ideas, beliefs, influence and sentiments; networks evolution; the policy implications of different modes of behaviour; fundamental theory and tools to operationalise narrative dynamics; computational theories of narratives, including Big Data; tools for processing narratives and sentiment; and predicting the emergence of narratives.

In this paper, I discuss the role that behavioural and experimental economics can play in improving agricultural policymaking. I do so by considering the development of an agri-emissions pricing policy in NZ. International literature shows that profit, as well as a range of other factors such as social norms and identity, drive farmer behaviour. This is particularly true for adoption of sustainable technologies and practices. A better understanding of farmer behaviour provides potential for: (1) an increased understanding of the uncertainty around policy modelling; (2) an increase in the accuracy of policy modelling, particularly when emission prices are low; (3) potential for new policy tools. Experimental economics provides a powerful methodology to build behavioural understanding and test policy tools. I argue that a behavioural economics perspective can contribute to agricultural policy, but add a note of caution that the gains to modelling accuracy and improved policy design are not guaranteed.

This article presents a model of consumer behavior that incorporates anchoring and price effects in describing purchase demand. The model, called F-Cap, for Finite Consumption Anchored to Price, offers an alternative to traditional microeconomic models of demand. This model is based on recent findings in psychology and behavioral economics and connects concepts from behavioral and traditional economics to the language and findings of behavior analysis. In particular, the model incorporates the idea of maximum consumption and reinforcement power developed in the exponential and exponentiated models of demand, and adds the possibility to estimate reference prices using a new, simpler estimation method. These elements are organized in a model based on the sigmoid function. A function estimation algorithm is proposed. This algorithm linearizes the function and estimates the parameters using ordinary least squares regressions. A core feature of the algorithm is that it allows the identification of reference prices, which is not possible in prior models. First, this article illustrates how the parameters of F-Cap modify the maximum level of consumption, the anchor point, and the decrease in consumption after that point, as proposed in the model. Next, using simulated data, the article shows that the algorithm estimates these parameters correctly both in standard and in mixed models. Third, the article presents evidence that F-Cap describes the behavior of human subjects in the hypothetical purchase task with less unexplained variance than alternative demand models. This function correctly estimates the parameters associated with the good's contribution to utility, which in behavior analysis language is equivalent to reinforcing power. It also estimates the response to reference prices, which can be interpreted as behavior governed by rules in the tradition of behavior analysis. The F-Cap model overall helps connecting the findings of operant behavioral economics with the practices of mainstream economics.

Behavioural Economics and Experiments addresses key topics within behavioural economics, exploring vital questions around decision-making and human nature. Assuming no prior knowledge of economics, the book features wide-ranging examples from literature, film, sport, neuroscience and beyond. Ananish Chaudhuri explores the complex relationships between human behaviour, society and decision-making, introducing readers to the latest work on heuristics, framing and anchoring, as well as ideas around fairness, trust and social norms. The book offers a fresh perspective on issues such as: Decision-making under uncertainty Firms' pricing decisions Employment contracts Coordination failures in organizations Preventing bubbles in financial markets This is an ideal introduction for students of behavioural economics, experimental economics and economic decision-making on economics, public policy, psychology and business-related programmes, and will also be accessible to policymakers and curious laymen.

This study aims to verify the main characteristics of the scientific production on behavioral finance applied to the area of investor relations. Through a bibliometric research carried out in the Scopus database, 121 publications were found, which were analyzed by statistical and graphic techniques. The results indicate a numerically reduced and volatile production of articles on the subject, without robust growth so far. Few documents were found by author, institution, and journal, as well as a small number of connections, concerning citations, among them. This research area is thus largely unexplored within behavioral finance, although academic production in behavioral economics on the use of prospects for selling complex products is proportionally very broad. Bibliographic coupling indicated four main themes, the most relevant being the influence of the different disclosure means of financial information on investor behavior. These results suggest that the subject has not aroused the interest of researchers and that, although relevant, it is still little explored. On the other hand, the results indicate a broad field for further studies. These findings are relevant, since they allow a clear and comprehensive view on a relevant and still little explored theme.

One of the key objectives of financial literacy studies is to translate financial knowledge into positive financial behavior. Thus, appropriate financial choices and sound decisions can be made. However, this translation is hindered by psychological factors. This study examines the factors that influence financial behavior in both theoretical and practical contexts through the lenses of behavioral and experimental economics. This research seeks to examine the financial behaviors of university students in Romania, Türkiye, and Ukraine, as well as the factors affecting them from this perspective. The data were analyzed using multiple regression and the Mann-Whitney U. The findings revealed that Turkish students’ financial behavior level is higher than their counterparts in Romania and Ukraine. It was found that having financial knowledge improves positive financial behavior. The results indicate a potential relationship between the financial behavior level and the principles of behavioral and experimental economics. It was concluded that rational decision-making, along with trust, can foster positive financial behavior. This study may motivate educational authorities to implement financial education, as it underscores the beneficial impact of financial knowledge on financial behavior. Given that the research highlights the importance of trust, it could assist market makers in fostering sustainable market trust.

The article analyzes the formation, spread and development of behavioral economics in microeconomic research, as well as its development in macroeconomic research over the past two decades. The key shortcomings of neoclassical macroeconomic models and their critique based on existing research and practical application by central bankers are highlighted. The key stages in the formation of behavioral macroeconomics, elements of which began to appear in the works of neoclassical macroeconomists, have been identified. The main arguments in favor of replacing neoclassical macroeconomic models with new behavioral macroeconomic models are presented, as well as key issues of behavioral macroeconomics and prospects for its further adoption as a basic concept for decision-making for governments. Key studies of behavioral economists on behavioral macroeconomic models, most of which are agents-based (microfoundations-based), have been identified and systematized. Based on the results of testing various behavioral models by world-renowned scientists, as well as our analysis, it is proposed to focus further macroeconomic research on behavioral models based on the activities of agents (microfoundations).