Background
Behavioural economics integrates insights from psychology with economic theory to better understand how individuals and institutions actually make decisions in the real world. Traditional economic models often assume that agents are rational, utility-maximizing entities with fixed preferences. In contrast, behavioural economics explores how real-world decisions often deviate from this paradigm due to various psychological influences.
Historical Context
The field of behavioural economics has its roots in the mid-20th century, gaining significant traction in the later decades as economists began to incorporate empirical findings from psychology. The seminal works of psychologists like Daniel Kahneman and Amos Tversky, particularly their studies on prospect theory, significantly influenced the field.
Definitions and Concepts
Behavioural Economics: A branch of economics examining how psychological, cognitive, emotional, cultural, and social factors affect economic decisions.
Beta-Delta Preferences: A mathematical representation used in behavioural economics to model temporally inconsistent decision-making. Specifically, with 0 < δ < 1 and 0 < β ≤ 1, where:
- β measures the degree of self-control, determining the present bias.
- δ represents the intertemporal discount factor.
- β = 1 represents exponential discounting, a scenario with no present bias.
Major Analytical Frameworks
Classical Economics
Classical frameworks generally assume rational decision-making, where individuals maximize utility based on stable preferences. Behavioural economics challenges this notion by introducing psychological factors into the analysis.
Neoclassical Economics
Similar to classical economics, neoclassical models assume rational agents. However, behavioural neoclassical economics integrates findings from behavioural studies to refine these models for greater realism.
Keynesian Economics
While Keynesian economics focuses on government intervention and macroeconomic policies, integrating behavioural aspects can provide insights into consumer confidence and spending behaviour.
Marxian Economics
Marxian perspectives emphasize class struggle and economic structures. Behavioural economics can complement these views by explaining individual choices within a socioeconomic context.
Institutional Economics
Institutional economics emphasizes the role of institutions in shaping economic behaviour. Behavioural insights can help explain how institutional norms and rules influence individual and collective economic actions.
Behavioral Economics
This field inherently focuses on the psychological underpinnings of economic choices, employing insights like loss aversion, prospect theory, and the role of heuristics and biases.
Post-Keynesian Economics
Post-Keynesians often critique mainstream economic theories, advocating for a broader understanding of economic dynamics that incorporates psychological realism akin to behavioural economics.
Austrian Economics
Austrian economics, which focuses on individual choices and market processes, can benefit from behavioural insights by understanding how cognitive biases affect entrepreneurial and market behaviour.
Development Economics
Understanding how behavioural factors affect decision-making is crucial for development policies aimed at improving welfare and economic outcomes in developing countries.
Monetarism
While monetarism primarily deals with the role of governments in controlling the money supply, behavioural economics offers insights into how psychological factors can affect consumption and saving decisions.
Comparative Analysis
Behavioural economics bridges gaps left by traditional economic theories, providing a more comprehensive understanding of decision-making processes that better reflect real-world complexities involving cognitive biases and psychological factors.
Case Studies
- Loss Aversion in Trading: Examines how behavioural biases, such as loss aversion, affect investor behaviour.
- Savings Behaviour: Studies how intertemporal choices, influenced by beta-delta preferences, impact individual’s savings decisions.
Suggested Books for Further Studies
- “Thinking, Fast and Slow” by Daniel Kahneman
- “Nudge: Improving Decisions About Health, Wealth, and Happiness” by Richard H. Thaler and Cass R. Sunstein
- “Predictably Irrational” by Dan Ariely
Related Terms with Definitions
- Prospect Theory: A behavioural economic theory that describes how people choose between probabilistic alternatives that involve risk.
- Heuristics: Mental shortcuts or rules of thumb that simplify decision-making.
- Anchoring: The cognitive bias of relying heavily on the first piece of information encountered.
- Nudges: Subtle policy shifts to guide people’s behaviour without restrictive measures.
