Is Behavioral Economics Doomed?

Introduction (Via DK Levine)

As Max Weber was a professor of economics, it is perhaps appropriate to discuss modern “behavioral economics” in a lecture in his honor. Indeed – modern economics has returned to many of the issues that fascinated Weber, ranging from political economy to the theory of organizations. Behavioral economics purports to be instrumental in these extensions – my goal in this lecture is to address the question of what – if anything – behavioral economics brings to economics.

Certainly behavioral economics is all the rage these days. The casual reader might have the impression that the rational homo economicus has died a sad death and the economics profession has moved on to recognize the true irrationality of humankind. Nothing could be further from the truth. Criticism of homo economicus is not a new topic. In 1898 Thorstein Veblen wrote sarcastically rational economic man as “a lightning calculator of pleasures and pains, who oscillates like a homogenous globule of desire of happiness under the impulse of stimuli.” This description had little to do with economics as it was practiced then – and even less now. Indeed, for a long period of time during the 60s and 70s, irrational economic man dominated economics. The much criticized theory of rational expectations was a reaction to the fact that irrational economic man is a no better description of us than that of a “lightning calculator of pleasures and pains.” In many ways the rational expectations model was a reaction to “[t]he implicit presumption in these … models … that people could be fooled over and over again,” as Robert Lucas wrote in 1995.

Excerpts (Via DKlevine)

Suppose that your lifetime wealth is $860,000 which is about the median in the United States. Suppose also that you are indifferent between a 70% – 30% chance of A: $40 and $32 and B: $77 and $2 – which many people are in the laboratory [Holt and Laury 2002]. Then your coefficient of relative risk aversion is 27,950. If this sounds like a big number it is. One important puzzle much studied by economists is why the rate of return on stocks is so much higher than on bonds, given that stocks are not all that much more riskier.

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10. July 2009 by Miguel Barbosa
Categories: Behavioral Economics, Curated Readings | Leave a comment

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