Why are We Irrational: The Path from Neoclassical to Behavioral Economics 2.0
Excerpt (Via Rick Bookstaber)
A few months ago I discussed the failing of econophysics, and more generally, the economic paradigm that treats people like computers and views economic dynamics like physics. The natural follow up question is, “What can you say that is constructive?” The answer is an emerging approach to behavioral economics.
Over the past few decades it has dawned on some researchers that we don’t make decisions the way most economists think we should. And as a result behavioral economics has become a burgeoning field of study. Initially, the bulk of this field consisted of cataloging behavior deemed aberrant and anomalous. That is, the underlying assumption was that the economic view of decision making is the correct one, and the economists need to see where people get it wrong. Thus, we had descriptions of behavioral economics such as “exploring limited rationality” and developing models for the “systematic imperfections in human rationality.” When inconsistencies between behavior and theory were demonstrated, the most charitable response from the neoclassical school was that maybe there was a missing factor; the theory was correct but not well parametrized. Unlike similar fields in psychology and biology, little time was spent on understanding how people think, why they think the way they do, and the ways the bedrock assumptions of economics based on mathematical methods and axioms of behavior might be off the mark.
And they probably are off the mark because, after all, neoclassical economics is missing half the story. It has left out any consideration of the context in which people make decisions, how that relates to people’s varied experience, environment, and the uncertainty they harbor about how the world might change in unanticipated ways — ways that cannot be captured through an enumeration of the probabilities of the possible states of nature. One field that does take this important (for humans) context into account is called behavioral ecology. It is not as well known in economics as it is in biological and psychological studies of behavior. Now, behavioral economics is incorporating this psychological realm.
This new approach is a quiet revolution that may transform the way we look at economic behavior. The era of mathematical, axiomatic views of human behavior will give way to approaches that start with how people look at decision making, understanding why they do that, and then understanding why that approach might have arisen evolutionarily and how it, rather than the utility maximization approach that has dominated the field for two generations, moves us closer to reality.
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