Written by: Anjali Kota
A relatively new field of study in the branch of economics is behavioral economics, the intersection of psychology and economics. The field of behavioral economics places an emphasis on why consumers make certain economic decisions by taking rational choice theory and interpreting it using actual consumer psychology. While traditional economics is based on “rational choice theory,” (the theory that individuals always make decisions based on weighing all costs and benefits and then making a careful decision) behavioral economics disproves that rational choice theory accurately represents consumers. In relation to traditional economics, behavioral economics serves to bolster neoclassical economics by rooting its theories in consumer psychology. However, throughout the development of this field, behavioral economics has faced contention of its place alongside and enriching traditional economics.
Many believe the concept of behavioral economics began with Adam Smith and his well-known concept of the “invisible hand” which is the belief in unseeable market forces that arise based on consumers’ and producers’ self-interest (Heath, 2016). Since then, the field has been bolstered by cognitive psychologists, Amos Tversky (who received his doctorate from the University of Michigan) and Daniel Kahneman, who researched heuristics and biases (Fox, 2015). Dan Ariely pioneered the idea of “Predictable Irrationality” in which people make decisions in a way that goes against the rational thought model but is universal, and most notably, Richard Thaler, dubbed “the father of economics” for his numerous theories regarding behavioral economics such as the idea of “nudge” where a small tweak to how the options are presented causes individuals to choose a different option (Witynski, n.d).
Since then, the field has been bolstered by innovative thinkers like Amos Tversky, Daniel Kahneman, Dan Ariely, and Richard Thaler. Tversky (who received his doctorate from the University of Michigan) and Daniel Kahneman are cognitive psychologists who research heuristics and biases. Dan Ariely pioneered the idea of “Predictable Irrationality” in which people’s choices go against the rational choice theory in a universal way. Most notably, Thaler was dubbed “the father of economics” for his revolutionary theories regarding behavioral economics such as the idea of a “nudge” (changing how options are presented can change which option is chosen). These aren’t the only individuals who have done work in behavioral economics. Other notable researchers include Gary Becker, George Akerlof, and many others.
To engage in neoclassical economics, the following assumptions must be made: those that make up an economic environment are independent, people make educated decisions based on all relevant information, consumers seek to maximize their utility, and producers seek to maximize their profit (Neo-Classical vs Behavioural Economics, n.d.). The problem of neoclassical economics that these researchers sought to address is that neoclassical economics fails to reflect reality as accurately as is now needed in the world of artificial intelligence and big data.
Today, we know that behavioral economics has far-reaching applications beyond its overarching theoretical component. One of these important applications is policy. By applying behavioral economics to policy, policymakers are able to more accurately analyze the effects of implemented policies. To do just that, the Behavioural Design Team was implemented in the United Kingdom in 2010 (National Academies of Sciences, Engineering, and Medicine, 2023). Since then, other countries have also implemented their own organizations that use behavioral economics to inform policy, such as the Social and Behavioral Sciences Team established in the US in 2015. Another important application of behavioral economics is in pharmaceuticals. According to a study done on the link between how research on a certain sector of pharmaceuticals has vastly improved the benefits from that sector: “Pharmaceutical domains where behavioral concepts have been investigated relate to influencing prescribing behavior, improving medication adherence, and increasing vaccination uptake,” (Vandenplas et al., 2022).
Still, many economists hesitate to fully switch over to a model that incorporates behavioral economics instead of the rational thought model. A debate between Nobel laureates Gene Fama and Richard Thaler arose about the argument of economic “bubbles,” (when the price of a good increases beyond the actual value of that good) in an interview with the Chicago Booth Review on the topic “Are Markets Efficient?” (Kenton, 2018). Fama explained the benefit of neoclassical economics and the rational thought model is that it provides a “systematic” way of defining these bubbles, simplifying a complex subject, and using the model to predict some sort of outcome and later inform decisions (Chicago Booth Review, 2016).
Another reason that economists argue to not trifle with the rational thought model is behavioral economics’ lack of application to traditional economics. One of the main critics of the portrayal of behavioral economics as the study of irrationality is Gerd Gigerenzer, a German psychologist. In a popular paper, “The Bias Bias in Behavioral Economics,” Gigerenzer argues against the oversimplified notion in behavioral economics that people are simply unaware of biases and that psychology can play a far more helpful role in economics than only being used to identify fallacies and errors in judgment (Gigerenzer, 2018). Gigerenzer’s argument brings up the idea of a complete overhaul in the study of behavioral economics to change the entire basis of which psychology and economics meet in analyzing consumer decisions.
Behavioral economics was originally formulated to help economists understand why consumers make the decisions that they do. Though there is a great amount of back and forth regarding the staying power of the field of behavioral economics in the minds of economists, its many beneficial returns in pharmaceuticals and policy, as well as the arguments that it proposes regarding consumer behavior hint at a continuation as well as expansion of the field. It can be hoped that through this expansion, the critiques of the lack of a universal process as well as the part that psychology plays in behavioral economics will be addressed.
References
Chicago Booth Review. (2016). Are Markets Efficient? (H. Weitzman, G. Fama, & R. Thaler, Eds.). The University of Chicago Booth School of Business. https://www.chicagobooth.edu/review/are-markets-efficient
Fox, J. (2015, April 16). From “Economic Man” to Behavioral Economics. Harvard Business Review. https://hbr.org/2015/05/from-economic-man-to-behavioral-economics
Gigerenzer, G. (2018). The Bias Bias in Behavioral Economics. Review of Behavioral Economics, 5(3-4), 303–336. https://doi.org/10.1561/105.00000092
Heath, E. (2016, November 2). Invisible hand | Definition, Economics, Example, & Facts | Britannica Money. Www.britannica.com. https://www.britannica.com/money/topic/invisible-hand
Kenton, W. (2018). Bubble. Investopedia. https://www.investopedia.com/terms/b/bubble.asp
National Academies of Sciences, Engineering, and Medicine. (2023). Behavioral Economics: Policy Impact and Future Directions. Washington, DC: The National Academies Press. https://doi.org/10.17226/26874.
Neo-classical vs behavioral economics. (n.d.). Www.legalleadership.co.uk. https://www.legalleadership.co.uk/knowledge/the-bigger-picture/finance-and-accounting/neo-classical-vs-behavioral-economics/Vandenplas, Y., Simoens, S., Turk, F., Vulto, A. G., & Huys, I. (2022). Applications of Behavioral Economics to Pharmaceutical Policymaking: A Scoping Review with Implications for Best-Value Biological Medicines. Applied Health Economics and Health Policy. https://doi.org/10.1007/s40258-022-00751-y