When Psychology Meets Economics

When Psychology  Meets EconomicsWhen Psychology  Meets Economics

The Nobel Prize committee announced American economist Richard Thaler as the winner of the 2017 Nobel Prize in Economic Sciences on Monday for his “contributions to behavioral economics”, a figure who is dubbed the “father of behavioral economics” and is well-known for his work on the “nudge-theory”.

This is the second time in the history of Nobel Economics that a behavioral scientist wins the prize. Previously, in 2002, psychologist Daniel Kahneman was the first non-economist to win the prize “for having integrated insights from psychological research into economic science, especially concerning human judgment and decision-making under uncertainty”.

Are our decisions rational? Unlike what was considered in classical economics, it does not seem to be so in modern times, and behavioral economics is the field that scientifically studies decision-making and related topics of valuation, exchange and interpersonal interactions. The field is an effort to merge psychological and cognitive theories (behind our choices) with economic ones (what we actually do). Kahneman believes that economics are “the study of the economic behavior of humans”. Behavioral economists try to bring the “human” factor back into the studies of economics as they think this element has been less attended to while the focus has been more on the economic part.

Our decisions are hugely dependent on various factors from the outside world, many of which could lead us to make wrong or irrational decisions: Emotions, mindsets, goals, the experiencing self and the remembering self as personal and individual factors, and the society and groups as social factors that affect our decisions, economic or otherwise.    

As a subfield of cognitive science, behavioral economics takes empirical findings from psychology, sociology and neuroscience into microeconomic theory and hands in models of economic decisions of individuals, thus striving to improve people’s decisions by for example making them conscious of biases and fallacies when confronted with choices. In reality, our decisions are not only prone to errors, but also these errors re-expose themselves all the time. The positive point is that all of this is not based on chance, but is identifiable and predictable, meaning that by taking the right course of action, we can diminish its effect in our daily lives.

Making decisions can seem largely intuitive—and intuitions don’t always lead to happy outcomes. Behavioral economics helps individuals reflect on the actual process of decision-making by taking control of the gears that rule the specific patterns of perception and cognition underlying our choices.

Biases, for example, unnoticed by our consciousness, would drive people to implement more of heuristics than rationales. An example of this could be the ‘endowment effect’ introduced by Thaler that people value objects in their possession as more valuable than the same objects not in their ownership.This leads to the situation where people are less willing to give away the possessions they have (loss-aversion). Now think of its large-scale aftermaths, especially when it comes to investment or trade of goods!

Of the most important subjects covered in this field are: simple rules or heuristics, the common internal guidelines people use to streamline decision making; probability-based decisions, the conversion of objective values into subjective ones; decision-making under risk and uncertainty; reason-based choice versus emotion-based choice; how consistency or time passage drives choices; social influences and habits in the decision-making process and many more.

Behavioral economics also benefits from the research in neuroscience. When combined together in order to better understand the deep substrates of our economic behavior, i.e. its neurobiological bases, the new field of neuroeconomics is created. This discipline enables us to gain a better understanding of the decision-making process by looking into the underlying biological motives of choices and their shortcomings handed to us over the humans’ evolutionary history.

Be it to the benefit of individuals, marketers, companies, financial and public policymakers and economies or nations, the outcome of the scientific experimental studies is that we can open new possibilities for our own behavior and for decision-making that can meaningfully improve our quality of life by applying the knowledge of self into numerous areas of life from individual choices to larger perspectives of organizational, national and international interactions all of which constantly involve a kind of choice to be made. 

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