Behavioral economics

discipline of economy studying the effects of psychological, cognitive, emotional, cultural and social factors on decisions

Behavioral economics, along with the related sub-field behavioral finance, studies the effects of psychological, social, cognitive, and emotional factors on the economic decisions of individuals and institutions and the consequences for market prices, returns, and resource allocation, although not always that narrowly, but also more generally, of the impact of different kinds of behavior, in different environments of varying experimental values.

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  • Since its inception nearly three decades ago, behavioural economics has upset the pristine premise of classical economic theory—the view that individuals will always behave rationally to achieve the best possible outcome. Today it’s clear that the vagaries of individual and group psychology can cause irrational decision making by both individuals and organizations, resulting in less than ideal outcomes.
    • Renee Dye, Olivier Sibony and Vincent Truong "Flaws in strategic decision making." McKinsey Quarterly (2008). p. 1
  • The essay discusses the rise of (modern) behavioral economics during the last few decades. In contrast to Louis Uchitelle’s assertion, in his Feb. 11, 2001, NY Times essay, that behavioral economics began in 1994, I would try to argue that it began during the 1950s and early 1960s, although some aspects of it had even emerged in the works of Marshall, Wesley Mitchell, J.M. Clark and others, before WWII.
Although contributions of many writers have helped the rise of behavioral economics including psychologists Kahneman and Tversky, I regard the works of George Katona and Herbert Simon instrumental in its rise. While the works of Katona and his colleagues at Michigan University led to the use of survey method in economics and its utilization in measuring the impact of consumer expectations on macroeconomic activity, the work of Simon at Carnegie Tech.(a tremendously stimulating intellectual environment for economic theorizing then) resulted in the important theoretical foundations of behavioral economics, such as the concept of bounded rationality. Interestingly enough, that stimulating environment also led to the many contributions of Franco Modigliani, M. Miller, and others, and the start of the rational expectations hypothesis by John Muth — a student of Simon and Modigliani.
[Other] characteristics of behavioral economics... include the utilization of the theoretical findings of psychology and other social sciences; its concentration on real observed behavior of economic agents; its rejection of the simplistic model of rational maximizing agents and its replacement with Simon’s bounded rationality; and its emphasis on the utilization of an interdisciplinary approach in economics.
  • Hamid Hosseini, "The Arrival of Behavioral Economics: From Michigan, or the Carnegie School in the 1950s and the early 1960s?." The Journal of Socio-Economics 32.4 (2003): 391-409.; abstract
  • In sum, we need to augment and amend the existing body of classical and neoclassical economic theory to achieve a more realistic picture of economic processes as well as a more accurate understanding of the equilibrium toward which these processes move.
    • Herbert A. Simon (1986) in Preface to: Gilad & Kaish (eds.), Handbook of Behavioral Economics, p. xvi

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