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Behavioral Economics: How Psychology Made Its (Limited) Way Back Into Economics



History of Political Economy 36.4 (2004) 735-760 Behavioral economics and its focus on the interrelations between economics and psychology is attracting increasing attention and recognition. In 1998, the Journal of Economic Literature published an article offering an overview of the connections between economics and psychology (Rabin 1998). In defense of his focus on the relevance of psychological findings for economics, the author noted: "Because psychology systematically explores human judgment, behavior, and well-being, it can teach us important facts about how humans differ from the way they are traditionally described by economists" (11). A year later, in 1999, Andrei Shleifer of Harvard University was awarded the John Bates Clark medal of the American Economic Association, which is a prize granted every other year to an exceptional economist under the age of forty. Shleifer was selected for the award for his research on securities markets and on the role of government in regulating markets and in fostering economic growth. In this work, he presented behavioral finance as an alternative to the efficient market hypothesis that has dominated finance for many years (Shleifer 2000). In particular, Shleifer demonstrated the oversimplification of the efficient market hypothesis both in the common assumption of perfect rationality and in the failure of arbitrage to adjust prices correctly, and he detailed the empirical failings of the hypothesis. In 2000, another year later, Matthew Rabin of the University of California at Berkeley won a MacArthur Foundation "genius" award, which included a $500,000 grant, given annually to outstanding scientists, writers, and artists. And one year later again, in 2001, he received the John Bates Clark medal, with the American Economic Association noting: "Matthew Rabin is an outstanding and strikingly original theorist who has enriched economics by rigorously incorporating well-documented psychological evidence about human behavior into economic models" (Uchitelle 2001a). Rabin's contributions to behavioral economics involve digesting large amounts of nuanced psychology, creating simple models capturing that psychology, and doing behavioral economics with those models. He has become known especially for his work on reciprocity, "present-bias" in time discounting, judgment biases, overprojection of current feelings into the future, and how moral rules differ from moral tastes. In 2001, the same year as Rabin's John Bates Clark medal, George Akerlof, Michael Spence, and Joseph Stiglitz shared the Nobel Prize "for their analyses of markets with asymmetric information." In his Nobel lecture titled "Behavioral Macroeconomics and Macroeconomic Behavior," Akerlof (2001) contended that behavioral phenomena such as reciprocity, fairness, identity, money illusion, loss aversion, herding, and procrastination explain poverty, unemployment, and the business cycle. Hence, he argued, macroeconomics must be based on behavioral economics. According to Louis Uchitelle (2001b) of the New York Times, Akerlof was doing some pioneering work in the field "more than 25 years ago, before behavioral economics had a name or critical mass." Stepping forward yet another year, the 2002 Nobel Prize was shared by Daniel Kahneman of Princeton University "for having integrated insights from psychological research into economic science, especially concerning human judgment and decision-making under uncertainty" and Vernon Smith of George Mason University "for having established laboratory experiments as a tool in empirical economic analysis, especially in the study of alternative market mechanisms." Kahneman, along with Amos Tversky, has used insights from psychology to demonstrate how human decisions may systematically depart from those predicted by standard economic theory and to formulate prospect theory as an alternative. He has further analyzed how human judgment may take heuristic shortcuts that systematically depart from basic principles of probability. Vernon Smith has been instrumental in establishing experiments as a tool in empirical economic analysis by developing an array of experimental methods and by setting standards for what constitutes a reliable laboratory experiment in economics. We will end our sketch of the increased attention for and recognition of behavioral economics yet one year later, in 2003, when Sendhil Mullainathan of the Massachusetts Institute of Technology was awarded a $500,000 MacArthur Fellowship for his "fresh and unconventional inquiries" in behavioral economics. In granting the fellowship to the youngest recipient of 2003, the MacArthur Foundation cited the twenty-nine-year-old's 1998...
Behavioral Economics: How Psychology Made Its (Limited) Way
Back Into Economics
Sent, Esther-Mirjam, 1967-
History of Political Economy, Volume 36, Number 4, Winter 2004,
pp. 735-760 (Article)
Published by Duke University Press
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Behavioral Economics: How
Psychology Made Its (Limited)
Way Back Into Economics
Esther-Mirjam Sent
Behavioral economics and its focus on the interrelations between eco-
nomics and psychology is attracting increasing attention and recogni-
tion. In 1998, the Journal of Economic Literature published an article
offering an overview of the connections between economics and psy-
chology (Rabin 1998). In defense of his focus on the relevance of psy-
chological findings for economics, the author noted: “Because psychol-
ogy systematically explores human judgment, behavior, and well-being,
it can teach us important facts about how humans differ from the way
they are traditionally described by economists” (11).
A year later, in 1999, Andrei Shleifer of Harvard University was
awarded the John Bates Clark medal of the American Economic As-
sociation, which is a prize granted every other year to an exceptional
economist under the age of forty. Shleifer was selected for the award
for his research on securities markets and on the role of government in
regulating markets and in fostering economic growth. In this work, he
presented behavioral finance as an alternative to the efficient market hy-
pothesis that has dominated finance for many years (Shleifer 2000). In
particular, Shleifer demonstrated the oversimplification of the efficient
Correspondence may be addressed to Esther-Mirjam Sent, Nijmegen School of Manage-
ment, University of Nijmegen, P.O. Box 9108, 6500 HK Nijmegen, The Netherlands; e-mail: I wish to thank Gregory Besharov, John Davis, Neil De Marchi, Craufurd
Goodwin, Shauna Saunders, Roy Weintraub, and participants at a Duke History of Political
Economy workshop for their valuable feedback. I am grateful for the support received from
the Netherlands Institute for Advanced Study in the Humanities and Social Sciences.
History of Political Economy 36:4 © 2004 by Duke University Press.
736 History of Political Economy 36:4 (2004)
market hypothesis both in the common assumption of perfect rationality
and in the failure of arbitrage to adjust prices correctly, and he detailed
the empirical failings of the hypothesis.
In 2000, another year later, Matthew Rabin of the University of Cali-
fornia at Berkeley won a MacArthur Foundation “genius” award, which
included a $500,000 grant, given annually to outstanding scientists, writ-
ers, and artists. And one year later again, in 2001, he received the John
Bates Clark medal, with the American Economic Association noting:
“Matthew Rabin is an outstanding and strikingly original theorist who
has enriched economics by rigorously incorporating well-documented
psychological evidence about human behavior into economic models
(Uchitelle 2001a). Rabin’s contributions to behavioral economics in-
volve digesting large amounts of nuanced psychology, creating simple
models capturing that psychology, and doing behavioral economics with
those models. He has become known especially for his work on reci-
procity, “present-bias” in time discounting, judgment biases, overprojec-
tion of current feelings into the future, and how moral rules differ from
moral tastes.
In 2001, the same year as Rabin’s John Bates Clark medal, George
Akerlof, Michael Spence, and Joseph Stiglitz shared the Nobel Prize
“for their analyses of markets with asymmetric information.” In his No-
bel lecture titled “Behavioral Macroeconomics and Macroeconomic Be-
havior, Akerlof (2001) contended that behavioral phenomena such as
reciprocity, fairness, identity, money illusion, loss aversion, herding, and
procrastination explain poverty, unemployment, and the business cycle.
Hence, he argued, macroeconomics must be based on behavioral eco-
nomics. According to Louis Uchitelle (2001b) of the New York Times,
Akerlof was doing some pioneering work in the field “more than 25 years
ago, before behavioral economics had a name or critical mass.”
Stepping forward yet another year, the 2002 Nobel Prize was shared
by Daniel Kahneman of Princeton University “for having integrated in-
sights from psychological research into economic science, especially
concerning human judgment and decision-making under uncertainty”
and Vernon Smith of George Mason University “for having established
laboratory experiments as a tool in empirical economic analysis, espe-
cially in the study of alternative market mechanisms.” Kahneman, along
with Amos Tversky, has used insights from psychology to demonstrate
how human decisions may systematically depart from those predicted
by standard economic theory and to formulate prospect theory as an
Sent / Behavioral Economics 737
alternative. He has further analyzed how human judgment may take heu-
ristic shortcuts that systematically depart from basic principles of prob-
ability. Vernon Smith has been instrumental in establishing experiments
as a tool in empirical economic analysis by developing an array of exper-
imental methods and by setting standards for what constitutes a reliable
laboratory experiment in economics.
We will end our sketch of the increased attention for and recogni-
tion of behavioral economics yet one year later, in 2003, when Sendhil
Mullainathan of the Massachusetts Institute of Technology was awarded
a $500,000 MacArthur Fellowship for his “fresh and unconventional
inquiries” in behavioral economics. In granting the fellowship to the
youngest recipient of 2003, the MacArthur Foundation cited the twenty-
nine-year-old’s 1998 paper “A Memory-Based Model of Bounded Ra-
tionality” as indicative of his broad-based approach to economics and
lauded his work at the intersection of economics and psychology. Mul-
lainathan’s research has focused especially on executive compensation,
the economic role of social networking, resource allocation within
extended families in developing countries, racial discrimination in the
American marketplace, and the limited use of checking accounts by the
This paper puts the present enthusiasm for what we label the “new”
behavioral economics of Shleifer, Rabin, Akerlof, Kahneman, and
Mullainathan—along with other well-known contributors such as Colin
Camerer, David Laibson, and George Loewenstein—in historical per-
spective by contrasting it with an earlier lack of interest in psychological
insights in general and comparing it with an earlier incarnation, which
we shall identify as “old” behavioral economics, in particular. The first
section offers a bird’s-eye view of historical connections between eco-
nomics and psychology. Section 2 then takes a closer look at old be-
havioral economics, while the next one considers the transitional period
between old and new behavioral economics, the latter of which is dis-
cussed in section 4. The fifth section suggests explanations for the rising
interest in behavioral economics.
1. Economics and Psychology
Economics as a discipline was established before psychology, which was
viewed as an adjunct to moral philosophy in the eighteenth century and
rose in the nineteenth century partly in response to the emergence of
738 History of Political Economy 36:4 (2004)
physiology. Whereas physiology viewed the body as a machine, psy-
chology translated this into a perspective on the mind as a machine.
In return, economists such as Francis Ysidro Edgeworth, Richard Jen-
nings, and William Stanley Jevons incorporated insights of (German)
psychologists such as Gustav Theodor Fechner, Ernst Weber, and Wil-
helm Wundt concerning connections among sensation, stimulus, and re-
sponse. Psychology in the late nineteenth century and early twentieth
century witnessed the rise of Freudianism and its focus on how repressed
memories influence unconscious behavior. This went against the mech-
anistic view, since it problematized the notions of sensation, stimulus,
and response. In response, economists started debunking and disregard-
ing psychology.
During the first half of the twentieth century, then, the little psychol-
ogy that did exist in much of economics was of mid-nineteenth-century
vintage.1At the same time, there were some connections between
psychology and early institutionalism2as well as serious disagreements
about the psychology-economics nexus between, for instance, Lionel
Robbins and Terence Hutchison.3Yet, Milton Friedman’s (1953) efforts
to shield the rationality assumption from criticism seemed to success-
fully sideline psychological considerations around the middle of the
twentieth century. In Friedman’s opinion, psychological assumptions
were largely irrelevant to the validation of theories. Instead, he argued,
these theories should be judged almost solely in terms of their instru-
mental value in generating accurate predictions. In light of the limited
availability of data, the lack of controlled experiments, and the absence
of crucial experiments, Friedman contended, standard economic theory
must be evaluated by its countless applications. We will return to these
arguments when we discuss new behavioral economics in section 4.
It should come as no surprise that Friedman’s provocative claims met
with skepticism, most notably from Paul Samuelson (1963) and Herbert
1. As noted earlier, a bird’s-eye perspective allows such generalized observations. At the
same time, the contributions of, for instance, John Maynard Keynes,Alfred Marshall, and oth-
ers were full of psychological allusions. See Lewin 1996 for further details.
2. Since we are merely setting the stage for the rise of “old” behavioral economics here,
we refer the reader to the following for detailed discussions of these connections: Lewin 1996,
Rutherford 1994, and Yonay 1998.
3. With the same caveat as in the previous note, the reader is referred to Blaug 1992, Cald-
well 1994, Hutchison 1938, and Robbins 1984 for details on the disagreements between Rob-
bins and Hutchison.
Sent / Behavioral Economics 739
Simon (1963).4Criticizing what he termed the F-twist, Samuelson in-
stead defended operationally meaningful theorems—a hypothesis about
empirical data that could conceivably be refuted if only under ideal
conditions—and a descriptivist view of the nature of scientific explana-
tion according to which theories are equivalent restatements of assump-
tions and conclusions. Simon took issue with what he labeled Friedman’s
“principle of unreality”; he instead proposed the “principle of continuity
of approximation,” according to which the derivations from assumptions
will be approximately correct if the conditions of the real world approx-
imate sufficiently well the assumptions of an ideal type. Since Simon’s
efforts were inspired by a desire to reestablish close connections between
psychology and economics, we will bid farewell to Samuelson now and
follow Simon and his contributions to psychology.5
Psychology underwent major transformations during the middle of
the twentieth century, partly due to Herbert Simon’s contributions to the
so-called cognitive revolution (Baars 1986; Mirowski 2002; Sent 2001),
which sought to undermine the dominance of behaviorism in psychol-
ogy. The latter had assumed that the only things that are real (or at least
of interest) are the things one can see and observe. While one cannot
see the mind, the id, or the unconscious, one can see how people act,
react, and behave. From behavior one may be able to make inferences
about the mind and the brain, but they were not the primary focus of the
investigation in behaviorism. Behaviorists had therefore hoped that it
would be possible, in principle, to secure a full, lawful explanation of
behavior, including verbal behavior in humans, in terms of present and
past behavioral, physiological, and environmental variables, in ways that
do not require mention of the mental. During and after World War II,
the development of complex servomechanisms and related human oper-
ator studies, as well as of digital communications and computer technol-
ogy, provided new insights into purposive behavior, new techniques for
studying it, and evocative analogies for psychology. In response, the cog-
nitive revolution in psychology resurrected the concept of mind and a fo-
cus on internal psychological processes.And thereby the way to renewed
4. It should perhaps also come as no surprise that Friedman responded with skepticism
when asked to chair Simon’s Richard T. Ely Lecture (Simon 1979), as illustrated by the fact
that he only grudgingly agreed to do so after Jacob Marschak, who had arranged the lecture,
died. In fact, Friedman asked Jack Hirschleifer to explain to him why Simon had been selected
to deliver the lecture.
5. See Wong 2003 for an insightful discussion of Samuelson’s contributions.
740 History of Political Economy 36:4 (2004)
connections between (cognitive) psychology and (old behavioral) eco-
nomics was opened.
This ends our admittedly crude overview of the historical connections
between economics and psychology, and brings us to a discussion of
Simon’s role in the establishment of old behavioral economics.
2. Old Behavioral Economics
In 1959, Herbert Simon wrote: “Recent years have seen important new
explorations along the boundaries between economics and psychology”
(253). However, it was not until the 1960s that explicit references to be-
havioral economics—as the efforts to incorporate psychological insights
into economics came to be known—began appearing (see, e.g., Cyert
and March 1963; Foote Whyte 1965; Bronfenbrenner 1966; and Katona
1968a, 1968b).6The early pioneers sought to characterize the effects of
a restricted rational agent on the assumptions (and conclusions) of eco-
nomic and administrative theory, especially in understanding organiza-
tions (see, e.g., Cyert and March 1963). A new technique used in the
early behavioral contributions was computer simulation. One reason was
that behavioral models are often too complex to be analyzed completely
by conventional techniques that lead to closed-form solutions. Simula-
tion studies allowed the exploration and analysis of previously inacces-
sible phenomena. Detailed computational models were set up to analyze
how people, tasks, and networks are interrelated in complex, dynamic,
and adaptive systems.
One can identify four groups of contributors to old behavioral eco-
nomics (Earl 1988; Gilad and Kaish 1986a, 1986b; Sent 1998b, 1998c,
1998d). The first, and most visible, was a group of researchers at Carne-
gie who focused on bounded rationality, satisficing, and simulations,
consisting of scholars such as Richard Cyert, James March, and Her-
bert Simon.7Much of this work was sponsored by the Ford Foundation
6. In light of the fact that the cognitive approach to psychology sought to undermine the
dominance of behaviorism in psychology, there is a linguistic irony in the fact that the efforts to
incorporate psychological insights into economics came to be known as behavioral economics.
7. Following Earl 1988, Oliver Williamson is intentionally not included in this group.
Williamson sought to link the idea of conflict of interest with the idea of information limitations
and saw organizational forms as implicit or explicit solutions to the problems of decision and
control created by opportunism and bounded rationality. Opportunism refers to the fact that
there is conflict of interest within, as well as between, organizations, and that participants in an
organization will lie, cheat, and steal in their own self-interest if they can. Bounded rationality
Sent / Behavioral Economics 741
and the Office of Naval Research (ONR).8Richard Nelson and Sidney
Winter subsequently extended these insights at Yale University.9Sec-
ond, a cluster of researchers at Michigan, led by George Katona, be-
came known for its interest in attitude research and psychological eco-
nomics. Whereas the Carnegie group focused mostly on firm behavior,
Katona’s followers were interested in consumer behavior and macro-
economic issues. Third, a group at Oxford highlighted the importance
of case studies, uncertainty, and coordination, with the participation of
P. W. S. Andrews, D. M. Lamberton, H. Malmgren, J. Marschak, G. B.
Richardson, and G. L. S. Shackle. Finally, a number of researchers at
Stirling stressed eclecticism and integration, as advocated by Neil Kay,
Brian Loasby, Richard Shaw, John Sutton, Andrew Tylecote, and Peter
Earl. What these approaches shared was a dismissal of the mainstream
focus on profit and utility maximization and equilibrium as well as an ef-
fort to develop an alternative. Within as well as outside of these groups,
behavioral economists contributed to macroeconomics (e.g., James Mor-
gan, Thomas Juster, and the Michigan Institute of Social Research), mi-
croeconomics (e.g., Harvey Leibenstein, John Tomer, and Randall Filer),
finance (e.g., Richard Thaler, Stanley Schachter, and psychologists at
Columbia University), the theory of the firm (e.g., Richard Cyert, James
March, Richard Nelson, and Sidney Winter), labor economics (e.g.,
Amyra Grossbard-Shechtman), and public finance (e.g., Howard Kun-
reuther and the Wharton group).
makes complete contracting infeasible because not everything can be known and there are lim-
its to the capabilities of decision makers for dealing with information and anticipating the fu-
ture. However, Williamson was reluctant to accept the notion of satisficing, primarily because
he thought it would denote irrational behavior. At the same time, Simon himself considered
satisficing to be a direct implication of bounded rationality. Perhaps somewhat surprisingly,
Simon (1987a) himself did include new institutional economics in his survey of behavioral
8. In fact, the Ford Foundation had a research area on behavioral science in the Carnegie
9. Nelson and Winter’s (1982) evolutionary theory of business firm growth brought new
impulses to behavioral modeling in economics. It emphasized differential survival as a pri-
mary basis for changing populations of firms, and saw firms as being selected upon by virtue
of their fit to the environment. Nelson and Winter stressed the inability of firms to carry out
the necessary calculations for optimization, because the firm will not “know” all the things of
which it is capable, because all future contingencies cannot be foreseen, because mistakes can
be made, and so forth. In Nelson and Winter’s view, the notion of satisficing can account for
persistence of routines in their evolutionary theory. At the same time, they resisted incorpo-
rating organizational motives, an insight considered to be central by the traditional Carnegie
742 History of Political Economy 36:4 (2004)
In the midst of so much diversity, these contributions to old behav-
ioral economics shared a dissatisfaction with mainstream economics and
a desire to develop an alternative using insights from (cognitive) psy-
chology (Earl 1988; Gilad and Kaish 1986a, 1986b; Simon 1987a).10
Whereas mainstream economics started from a given utility function,
old behavioral economics focused on discovering the empirical laws that
described behavior correctly and as accurately as possible. While the
neoclassical approach established a close connection between rational-
ity and utility or profit maximization, old behavioral economics scru-
tinized the implications of departures of actual behavior from the neo-
classical assumptions. And whereas mainstream economics started from
given alternatives and known consequences, old behavioral approaches
began with empirical evidence about the shape and content of the utility
Partly due to its explicit efforts to distance itself from the mainstream,
old behavioral economics never caught on in economics “proper.” Dis-
illusioned, Simon left the Graduate School of Industrial Administration
at Carnegie Mellon University in the 1970s for the psychology depart-
ment at the same institution, noting: “My economist friends have long
since given up on me, consigning me to psychology or some other dis-
tant wasteland” (Simon 1991, 385). As the introduction has illustrated,
however, psychology is no longer considered a distant wasteland. As the
following sections argue, this is partly because new behavioral econom-
ics situated itself squarely within the mainstream, which itself under-
went transformations as well, in the 1990s. First we will follow the fate
of behavioral economics during the transition period of the 1970s and
1980s in an effort to understand the insights from which new behavioral
economics developed.
3. Transition from Old to
New Behavioral Economics
The roots of new behavioral economics may be traced to the 1970s and
the work of especially Amos Tversky and Daniel Kahneman, but also
Baruch Fischoff, Paul Slovic, and others (Camerer 1999; Kahneman and
Tversky 1974, 1979; Kahneman, Slovic, and Tversky 1982; Laibson and
10. See, e.g., Gilad, Kaish, and Loeb 1984, 5: “All agree that the neoclassical model of
perfect information availability, optimal information processing, and the utility maximization
that results is in severe need of overhaul.”
Sent / Behavioral Economics 743
Zeckhauser 1998; Rabin 1996; Tversky and Kahneman 1987).11 Kahne-
man obtained a Ph.D. in psychology from the University of California
at Berkeley in 1961 and has been Eugene Higgins Professor of Psychol-
ogy and Professor of Public Affairs at Princeton University since 1993.
Tversky earned his Ph.D. in psychology from the University of Michi-
gan in 1964. At the time of his death in 1996, he was the Davis Brack
Professor of Behavioral Sciences in the Department of Psychology at
Stanford University. Starting from the perspective of expected utility-
maximization and Bayesian probability judgments, Kahneman, Tversky,
and their followers evaluated the cognitive character of conformity or
deviation from these benchmarks. It is important for our narrative con-
cerning the nonmainstream roots of old behavioral economics and the
mainstream ones of new behavioral economics to highlight that Kahne-
man and Tversky started from the rationality assumption that has char-
acterized mainstream economics and next analyzed departures from this
yardstick, as opposed to developing an alternative one. Colin Camerer
(1999) noted:
This sort of psychology provided a way to model bounded rationality
which is more like standard economics than the more radical depar-
ture that Simon had in mind. Much of behavioral economics consists
of trying to incorporate this kind of psychology into economics.12
The contributions of Kahneman and Tversky may be divided into
three areas: heuristics and biases, framing effects, and prospect theory.
First, they considered the importance of heuristics and biases in decision
making under uncertainty. Kahneman and Tversky found that shortcuts
in reasoning, employing representativeness, availability, and anchoring
as well as systematically erroneous judgments, were rampant. Second,
they studied framing effects, preference reversals, and related phenom-
ena, discovering that the details of the phrasing or structure of a deci-
sion problem can affect the choices that a person makes. Kahneman and
Tversky next formalized their insights in the shape of prospect theory, a
descriptive theory of decision making under risk that stresses the influ-
ence of status quo and reference points on tastes and choices. Their in-
sights were picked up by Richard Thaler, the Robert P. Gwinn Professor
11. The roots could be traced back even further to Ward Edwards in the 1950s, but this
would not change the main argument in this paper.
12. Also see Kahneman 2003, 1449: “The rational-agent model was our starting point and
the main source of our null hypotheses.”
744 History of Political Economy 36:4 (2004)
of Behavioral Science and Economics at the University of Chicago, who
earned his Ph.D. in economics from the University of Rochester. Thaler
has collaborated with Kahneman on many projects and has made main-
stream contributions to consumer choice, self-control, savings behavior,
and finance, among others. Thaler, in turn, influenced new behavioral
economists such as Colin Camerer, Linda Babcock, Catherine Eckel,
George Loewenstein, and Matthew Rabin. And the youngest guard in-
cludes David Laibson, Terry Odean, and Sendhil Mullainathan, as well
as others. Along the way, Eric Wanner of the Alfred P. Sloan Foundation
and subsequently the Russell Sage Foundation played a critical role in
funding these efforts (Laibson and Zeckhauser 1998, 19).13
Yet, we are jumping ahead of our story to the rise of new behavioral
economics in the 1990s, which we will discuss in the next section, and
need to step back to discuss how the 1980s witnessed the institutionaliza-
tion of behavioral economics, with the foundation of the Society for the
Advancement of Behavioral Economics in 1982, the start of the Journal
of Economic Behavior and Organization in 1980 as well as the Journal
of Economic Psychology in 1981, the organization of the first Annual
Conference on Behavioral Economics in 1984 as well as a conference
titled “The Behavioral Foundations of Economic Theory” in 1985, and
the publication of a two-volume anthology (Earl 1988), two handbook
editions (Gilad and Kaish 1986a, 1986b), and one volume covering ad-
vances in the field (Green and Kagel 1987). These developments were
accompanied by disagreements over what exactly was being institution-
alized, which is perhaps best exemplified by two contrasts, between (and
among) contributors to Rational Choice: The Contrast between Eco-
nomics and Psychology (Hogarth and Reder 1987) and Vernon Smith,
as evidenced by his critical review of the book (Smith 1991), as well
as between the Handbook of Behavioral Economics (Gilad and Kaish
13. While at the Sloan Foundation, Eric Wanner, a psychologist, was eager to get
economists and psychologists talking to one another. After he became president of the Russell
Sage Foundation, Wanner continued supporting (new) behavioral economics. In 1986, Sage
started a behavioral economics program jointly with the Sloan Foundation with the aim of
strengthening the accuracy and empirical reach of economic theory by incorporating informa-
tion from neighboring social science disciplines, especially psychology and sociology. Since
1992, the Sage Foundation has supported two principal activities in behavioral economics—a
series of workshops run by the National Bureau of Economic Research (NBER) and the Be-
havioral Economics Roundtable, a forum for discussing new ideas and encouraging younger
social scientists to enter the field. Sage also sponsors the Summer Institute for Behavioral Eco-
nomics, which is designed to introduce Ph.D. students and new junior faculty—also known as
“campers”—to the methods and findings of behavioral economics.
Sent / Behavioral Economics 745
1986a, 1986b), on the one hand, and Advances in Behavioral Economics
(Green and Kagel 1987) and Behavioral Economics (Earl 1988), on the
other hand, three efforts to anthologize the field.14
First, inspired by (mainly experimental) evidence documenting sys-
tematic departures from rational choice, Robin Hogarth and Melvin
Reder (1987) organized “The Behavioral Foundations of Economic The-
ory,” a conference held at the University of Chicago on 13–15 October
1985 that sought to meet three objectives. First, the conference addressed
the implications of the rationality assumptions underlying economics.
Second, it assessed the importance of evidence documenting violations
of rational behavior for the development of both theoretical and applied
economics. Finally, it provided a mechanism whereby both economists
and psychologists could profit from being exposed to different perspec-
tives. The conference included a wide variety of participants, including
Kenneth Arrow, Gary Becker, Daniel Kahneman, Robert Lucas, Charles
Plott, Herbert Simon, and Amos Tversky. It witnessed efforts at recon-
ciliation,15 but also serious disagreements. For instance, the conference
organizers’ stress on “a growing body of evidence—mainly of an ex-
perimental nature—that has documented systematic departures from the
dictates of rational economic behavior” (Hogarth and Reder 1987, vii)
displeased Vernon Smith (1991), who claimed that experimental eco-
nomics “documents a growing body of evidence that is consistent with
the implications of rational models” (878).16 These were not the only
disagreements that appeared in the 1980s.
14. See Earl 1988, 1:2: “An editor assigned the task of gathering a selection of key readings
in a particular field cannot justifiably claim that the resulting work has not been shaped by his
or her predispositions.”
15. For instance, Amos Tversky and Daniel Kahneman (1987, 88–89) wrote: “The present
results and analysis—particularly the role of transparency and the significance of framing—
are consistent with the conception of bounded rationality originally presented by Herbert
Simon....Indeed, prospect theory is an attempt to articulate some of the principles of per-
ception and judgment that limit the rationality of choice.”
16. Also see Smith 1998, 105: “Our scientific advance is handicapped by our failure to
pursue the exciting implications of the fact that things sometimes work better than we had a
right to expect from our abstract interpretations of theory.” Note that in his focus on the con-
sistency between experiments and the implications of rational models, Smith distorted Simon’s
contributions by arguing that the latter’s interest in “satisficing” and “bounded rationality” was
secondary. See Smith 1991, 888: “Simon’s thinking was ultimately transformed into concepts
of ‘satisficing’ and ‘bounded rationality,’ which were secondary interpretations of the more
fundamental characteristic of humankind.” For more on the disagreements between Simon and
Smith, see Lee 2003, 2004 and Starbuck 1963.
746 History of Political Economy 36:4 (2004)
Consider the editorial efforts on the part of Leonard Green and John
Kagel in their Advances in Behavioral Economics (1987). Not surpris-
ingly, they saw the investigation of the interrelations between economics
and psychology as one of the defining features of behavioral economics.
Green and Kagel added another characteristic, which is the use of lab-
oratory experimental methods for investigating economic outcomes in
a market context. Whereas most behavioral economists have sought to
incorporate cognitive psychology, as discussed in the previous sections,
and have focused on the decision-making process, Green and Kagel al-
luded to behaviorist psychology (Lewin 1996) and limited their attention
to the market level, with no serious interest in cognition or the mind.17
Green and Kagel included contributions by mainstream economist Gary
Becker as well as mainstream critic Herbert Simon in their edited vol-
ume, arguing that their diverse insights can be reconciled through animal
experimentation. So, in the end, the volume was inspired by an effort to
advance the “animal program in behavioral economics.”18
In contrast with Green and Kagel’s edited volume, the Handbook of
Behavioral Economics (Gilad and Kaish 1986a, 1986b) and Behavioral
Economics (Earl 1988) endeavored to embrace multiple interpretations
of behavioral economics. Benjamin Gilad and Stanley Kaish’s first vol-
ume included a preface penned by Herbert Simon, with no effort to sub-
sume it under their own umbrella, and the editors counted Keynesians,
post-Keynesians, institutionalists, Austrians, and neoclassical econo-
mists among the partisans of behavioral economics. Gilad and Kaish
only implicitly appealed to the interlinkages between economics and
psychology when suggesting that behavioral economists adhere to three
postulates. First, economic theory must be consistent with the accumu-
lated body of knowledge in the behavioral disciplines. Second, it should
concentrate on and be able to explain real observed behavior. Finally,
it should be empirically verifiable, for instance through experimental
economics. More explicitly, the editors associated behavioral econom-
ics with a growing dissatisfaction with mainstream economics, focusing
17. The stress on markets in the United States stands in sharp contrast with the game theo-
retic version of experimental economics developed by Germans. The latter is concerned with
the decision-making process as opposed to its outcome, and therefore regards aspirations as a
primary explanatory variable (Bolle and Carlberg 2001).
18. Some contributors mistakenly claim that behavioral economics “has focused almost
exclusively on findings produced in the animal laboratory” (Quiñones, Hayes, and Hayes 2000,
163), perhaps illustrating the strategic use of a title such as Advances in Behavioral Economics
for an edited volume with a specific agenda.
Sent / Behavioral Economics 747
on four specific objections. First, the editors contended, behavioral eco-
nomics rejects positivism. Second, it refuses to accept deductive reason-
ing. Third, it focuses on disequilibrium processes as opposed to equilib-
rium outcomes. Finally, behavioral economics objects to the simplistic
economic models employed by the mainstream. Instead, it seeks substi-
tutes for utility maximization, focuses on organizational identification,
and endeavors to develop a behaviorally modified objective function,
in the opinion of Gilad and Kaish. Peter Earl’s Behavioral Economics
(1988) similarly stressed the diversity of behavioral economics and its
opposition to the mainstream. More explicitly, the editor made an im-
passioned plea for not counting Oliver Williamson and Kenneth Arrow
among the partisans of behavioral economics. Labeling them pseudo-
behavioralists because of their orthodox inclinations, Earl criticized
Williamson for maintaining constrained maximization and failing to em-
brace satisficing and saw Arrow as a threat to behavioral economics be-
cause he sought to incorporate it into the mainstream and desired a
As noted at the start of this section, however, new behavioral eco-
nomics drew primarily on the work of Kahneman and Tversky in the
1970s and their insights on deviations from the benchmark of rational-
ity. Hence, despite the efforts of Gilad, Kaish, and Earl, the transition
period ended in favor of efforts to strengthen mainstream economics by
taking rationality as the yardstick as opposed to ones to develop an al-
ternative squarely based on bounded rationality. This, finally, brings us
to the 1990s and the rise of new behavioral economics and the need for
a more detailed discussion than the quick overview offered in the intro-
4. New Behavioral Economics
David Laibson of Harvard University, Sendhil Mullainathan of the Mas-
sachusetts Institute of Technology, George Loewenstein of Carnegie
Mellon University, Colin Camerer of the California Institute of Tech-
nology, and Matthew Rabin of the University of California at Berkeley
are now household names for those interested in behavioral economics.
Inspired by empirical and experimental counterevidence to the strong
rationality assumptions employed in mainstream economics and by the
19. Also note, therefore, that, contrary to Smith (1991), Earl did see “satisficing” as an
integral component of behavioral economics.
748 History of Political Economy 36:4 (2004)
rise of the metaphor of the brain as an information-processing device
in cognitive psychology, they formalize and test psychological predic-
tions. After identifying ways in which behavior differs from the main-
stream model, they show how alternate theories can explain apparent
anomalies. Along the way, they argue that market forces such as com-
petition and arbitrage, learning on the part of decision makers, and some
sort of evolutionary mechanism cannot eliminate the importance of their
Whereas Friedman (1953) had earlier argued against considering the
realism of assumptions (see section 1), “behavioral economics increases
the explanatory power of economics by providing it with more realistic
psychological foundations” (Camerer and Loewenstein 2004, 3). And
whereas Friedman had also highlighted the lack of controlled experi-
ments and the absence of crucial experiments, new behavioral econom-
ics relies heavily on experiments “because experimental control is excep-
tionally helpful for distinguishing behavioral explanations from standard
ones” (7). In addition, it uses field data, field experiments, computer sim-
ulation, brain scans, and so on.
Mullainathan and Thaler (2000) identify three ways in which this new
behavioral economics deviates from the standard, mainstream model.
First, under bounded rationality conditions, humans are faced with lim-
ited cognitive abilities that constrain their problem-solving abilities. Sec-
ond, bounded willpower illustrates that people sometimes make choices
that are not in their long-run interest. Finally, bounded self-interest
shows that humans are often willing to sacrifice their own interests to
help others. The size of the deviation determines the extent to which
economics’ conception of human choice needs to be modified. Rabin
(1998) suggests three “degrees of deviation.” First, there is evidence re-
quiring relatively small modifications of the utility functions economists
employ. This includes data illustrating that preferences are determined
by changes in outcomes relative to a certain reference level. That is, de-
cision makers’ dislike for losses outweighs their desire for gains. Also,
evidence that people pursue “other-regarding” goals such as fairness, re-
ciprocal altruism, and revenge might not require a complete overhaul of
the mainstream model. The next set of insights focuses on biases in judg-
ment under uncertainty and calls for a more radical challenge to the stan-
dard model. They show that humans often infer too much from too little
20. Economists such as George Akerlof, Robert Frank, and Robert Shiller also have an in-
terest in behavioral economics, but draw less explicitly on psychology.
Sent / Behavioral Economics 749
evidence and misread evidence as confirming their hypotheses. Finally,
the most radical critique includes support for the insight that people have
difficulties evaluating their own preferences. There is also confirmation
of framing effects, preference reversals, and related phenomena. And
there is evidence of self-control problems and a focus on short-run grat-
ification inconsistent with long-run preferences.
Behavioral insights have been applied in particular in an effort to un-
derstand finance and saving behavior. The success of behavioral finance
is attributable to its sharp, testable predictions and wide availability of
data contradicting the efficient market hypothesis, thereby showing that
arbitrage, learning, and evolution do not eliminate human limitations
and complications. In saving, behavioral insights focus on the complex-
ity of the calculations and the boundedness of willpower. They have also
inspired research in fields such as labor economics, law and economics,
and corporate finance. What many of these contributions share is an ef-
fort to translate experimental and other evidence into formal economic
Overall, as noted before, new behavioral economics is situated within
the mainstream. This is evidenced by, for instance, the following quo-
tation from two of the editors of the recently published Advances in
Behavioral Economics (Camerer, Loewenstein, and Rabin 2004):
At the core of behavioral economics is the conviction that increas-
ing the realism of the psychological underpinnings of economic anal-
ysis will improve economics on its own terms....This conviction
does not imply a wholesale rejection of the neoclassical approach to
economics....The neoclassical approach is useful because it pro-
vides economists with a theoretical framework that can be applied to
almost any form of economic (and even non-economic) behavior, and
it makes refutable predictions. (Camerer and Loewenstein 2004, 3)21
According to Richard Thaler, a pioneer in the field of new behavioral
economics, “many economists have been worried that studying these
topics is a risky career path; they now have recognition that behavioral
21. Also see Kahneman 2003, 1469: “Theories in behavioral economics have generally re-
tained the basic architecture of the rational model, adding assumptions about cognitive lim-
itations designed to account for specific anomalies.” And see Rabin 1998, 12–13: “Main-
stream economics employs a powerful combination of methods....Ibelieve these methods
are tremendously useful, and...weshould strive to understand psychological findings in light
of these methods. These methods raise problems for doing full justice to behavioral reality.”
750 History of Political Economy 36:4 (2004)
economics is no longer considered radical” (Uchitelle 2001a).22 This
raises the questions as to why economists can now safely embrace new
behavioral economics’ insights without any fear of being ostracized by
the profession and why the incorporation of psychological insights into
economics is now welcomed by the mainstream. This is the topic of the
next section.
5. Background to Rising Interest in Psychology
While new behavioral economics seeks to strengthen mainstream eco-
nomics, there is nothing inherent in appeals to psychological insights
that requires this, as witnessed by older efforts to develop behavioral
economics as an alternative to the mainstream.23 Yet, whereas old be-
havioral economics never really caught on, new behavioral economists
are the rising stars of the profession. So what changed? There are two
answers to this question, namely both behavioral economics and main-
stream economics evolved. The former answer, concerning the differ-
ence between old and new behavioral economics, has been addressed
throughout our narrative. Old behavioral economics relied heavily on
the insights of Simon, who started from a conviction that neoclassical
economists were not all that serious about describing the formal foun-
dations of rationality, whereas he was (Sent 1997, 1998c, 1998d; Simon
1959, 1982, 1987a, 1987b).Yet, Simon’s ideas are missing from the more
recent developments.24 Instead, these rely on the insights from Kahne-
man and Tversky that use the rationality assumption of mainstream eco-
nomics as a benchmark from which to consider deviations. The second
answer to our question about change, concerning the evolution of main-
stream economics, has remained in the background so far and requires
separate consideration here.
22. And Matthew Rabin (1998, 41) notes that “the aggressive uncuriosity shown in the past
toward behavioral economics continues to diminish.”
23. Also see Camerer and Loewenstein 2004, 5: “While the papers in this book largely
adhere to the basic neoclassical framework, there is nothing inherent in behavioral economics
that requires one to embrace the neoclassical economic model.”
24. This is symptomatic for Simon’s relative lack of lasting impact on any of the disci-
plinary domains through which he passed during his career. For instance, despite his criti-
cism of the theoretical outlook in political science and management theory, Simon has not
contributed extensive empirical studies. Despite his pathbreaking work on the serial symbol-
processing hypothesis in cognitive psychology and artificial intelligence, Simon’s contributions
are rather outdated in the face of the current focus on parallelism and connectionism.
Sent / Behavioral Economics 751
Whereas elegant mathematics had left little to no room for messy
psychology (Camerer 1999; Laibson and Zeckhauser 1998; Mirowski
2002), new space for psychological insights was created when main-
stream economics encountered mathematical difficulties. Since these
have been discussed in great length elsewhere (see, e.g., Arrow 1987;
Mirowski 2002; Mirowksi and Hands 1998; Rizvi 1991, 1994; Sent
1998a; and Weintraub 1991), we will only touch on some of them only
briefly here, focusing on general equilibrium theory, game theory, and
rational expectations economics.
First, consider general equilibrium theory and the Sonnenschein-
Debreu-Mantel result (see Sonnenschein 1972; Debreu 1974; and Man-
tel 1976).25 In 1972, Sonnenschein considered the restrictions imposed
on the structure of aggregate demand functions; in 1974, Debreu contin-
ued this line of work. Their findings are that under standard assumptions
on the individual consumers, like strict convexity and monotonicity of
preferences, so that each agent is characterized by textbook indifference
curves and a positive bundle of endowments of all goods, we can derive
an excess demand curve for each individual. Summing over all individ-
uals, of whom it is assumed that there are only a finite number, gives
the excess demand curve for society as a whole. Under certain not-very-
restrictive conditions, three properties will carry over from the individ-
ual’s excess demand curve to the aggregate demand curve: continuity, a
value of total excess demand that must equal 0 at all prices, and excess
demand that is homogeneous of degree 0. However, Sonnenschein and
Debreu found that these three properties are the only properties that carry
over from the individual to the aggregate demand function. In particu-
lar, the weak axiom of revealed preference (WARP) may not be satisfied
at the aggregate level. Yet, if we are to obtain uniqueness and stability
of equilibria, some such restrictions must be imposed. Hence, if WARP
is imposed on aggregate excess demands, the economy is presumed to
act as if it were just one big consumer. This line of work did not remain
isolated, and research by Mantel showed that the same situation obtains
even if the class of admissible preferences is restricted even further.
Next, consider game theory and the frictions within the Nash pro-
gram (Aumann 1981, 1986, 1997; Rizvi 1994, 1998; Rubinstein 1998;
Sent 2004). First, the folk theorem illustrates the (very real) possibility
25. For simplicity, this paper will limit its case to an exchange economy. However, matters
get worse, not better, by the introduction of production (see Kirman 1992 and Ingrao and Israel
752 History of Political Economy 36:4 (2004)
of encountering multiple equilibria in repeated games.26 Second, intu-
itively unreasonable equilibria may be selected in the finitely repeated
prisoner’s dilemma game (Aumann 1989, 86), the chain store paradox
(Selten 1978), and the centipede game (Rosenthal 1981). Finally, Nash
equilibria call for requirements such as common knowledge that are so
stringent that they have resulted in theorems concerning the nonexis-
tence of trade and the impossibility of “agreeing to disagree” about an
event (Aumann 1976; Milgrom and Stokey 1982; Rizvi 1994, 1998).
Still, as illustrated by Rubinstein (1998, 59), “‘speculative trade’ cannot
be explained as an outcome of different information structures.”
Finally, rational expectations economics was inspired by an effort
to establish symmetry by positing rational expectations on the part of
economists, governments, and agents. However, this opened the door
for several paradoxes (Sent 1998a). First, how can there be trade among
economic agents who are alike in these dimensions? One suggestion,
following a line of research started by Lucas (1972), is that equilib-
rium probability beliefs differ and that agents actually trade on the ba-
sis of different information. However, a whole series of no-trade theo-
rems overrule this commonsense intuition (see Hakansson, Kunkel, and
Ohlson 1982; Milgrom and Stokey 1982; Rubinstein 1975; Tirole 1982;
and Varian 1987). The second obstacle encountered by rational expec-
tations economists involved error term justification. In particular, close
scrutiny of the justification of error terms revealed that the econometri-
cian needed to be outwitted by the agents. As Lucas and Sargent (1981,
xxii) explained: “Errors in the estimated equation crop up perhaps be-
cause the econometrician has less information than the agents, in some
sense, or else because the model is misspecified in some way.”27 Finally,
how can policy recommendations be made when agents, economists,
and governments are put on an equal footing based on rational expecta-
tions? When policy recommendations are possible, symmetry is impos-
sible. For, making recommendations for improving policy amounts to
assuming that in the historical period the system was not really in a ratio-
nal equilibrium. When symmetry is possible, policy recommendations
26. The folk theorem states that in infinitely repeated games, for a range of discount factors
that are high enough—though less than one—any payoff vector that is feasible in the set of pay-
offs between two players who are simultaneously individually rational is a Nash equilibrium
27. Lucas and Sargent (1981, xxii) also noted that the “model misspecification route seems
less likely to deliver error terms with the good statistical properties—namely, certain orthogo-
nality properties.”
Sent / Behavioral Economics 753
are impossible. For, making the assumption that in the historical period
the system was in a rational equilibrium raises the question of why we
study a system that we cannot influence.
These mathematical difficulties encountered by mainstream econom-
ics facilitated not only the incorporation of psychological insights in
general, but also encouraged efforts to integrate some bounded rational-
ity in particular into mainstream models. For instance, game theorists
have looked toward bounded rationality in their efforts to save the ra-
tionality of the Nash equilibrium (Sent 2004). First, bounded rational-
ity functioned as a dynamic for selection among multiple equilibria by
promising to “refine” equilibria. Moreover, the evolutionary stable strat-
egy concept of evolutionary game theory may be viewed as a further re-
finement of perfect equilibrium, one of the most common notions used
to refine the Nash equilibrium.28 Second, bounded rationality has been
used to rule out unintuitive equilibria in the prisoner’s dilemma game, the
chain store paradox, and the centipede game. Third, absence of a fully ra-
tional treatment of knowledge may circumvent the no-trade theorems by
allowing speculative trade.These attempts to strengthen Nash, then, lead
to the paradoxical observation that “rationality in games depends criti-
cally on irrationality” (Aumann and Sorin 1989, 37). Similarly, rational
expectations economists have sought to reinforce the rational expecta-
tions hypothesis by focusing on convergence to this equilibrium through
boundedly rational “learning” (Sent 1997, 1998a). They have also used
bounded rationality to deal with some of the problems associated with
rational expectations such as multiple equilibria and the computation of
6. Conclusion
Behavioral economics is now the topic of Nobel lectures. The NBER
hosts conferences on behavioral economics. Graduate programs such
as the one at the University of Chicago organize behavioral seminars.
Behavioral economists hold positions at prestigious institutions such as
Harvard University. The field is represented by journals, anthologies, and
associations. And the New York Times publishes popular pieces about
the rise of behavioral economics. In short, behavioral economics has
28. Interestingly, such evolutionary mechanisms are more effective the less sophisticated
players are assumed (or allowed) to be (Vega-Redondo 1996, 186–94).
754 History of Political Economy 36:4 (2004)
George Akerlof (2001) concluded his Nobel lecture with the observa-
tion that behavioral economists have discovered the wild side of eco-
nomic behavior. In Akerlof’s opinion, behavioral economists are lion
tamers. As this paper has shown, their taming efforts have been focused
on not only the economy but also their fellow economists. In the 1960s,
appeals to psychology on the part of behavioral economists were de-
signed to develop an alternative to the mainstream model. Firmly rooted
in its mathematical models, the mainstream exhibited little interest in
these efforts. In the 1970s, cognitive psychologists suggested ways to
incorporate behavioral insights in ways that provided less of a threat to
the standard model. At the same time, the mathematical foundations of
mainstream economics started showing some flaws. In the 1980s, dis-
agreements emerged between old and new behavioral economists, with
the latter emerging as the victors in the 1990s, partly because Simon
abandoned his efforts and partly because new behavioral economists
suggested ways in which their insights may help rebuild the mainstream
A slightly different perspective on these developments might high-
light the observation that the present situation in mainstream economics
could be characterized as one of moderate pluralism (Sent forthcoming).
Sheila Dow (2002, 7) explains: “There is in particular a bifurcation be-
tween theoretical and applied mainstream economics. Both theoretical
and applied models, in turn, are often partial.” Recent years have wit-
nessed not only efforts to incorporate bounded rationality approaches
and behavioral insights, but also chaos theory, complexity approaches,
and experimental methods. Therefore, the benchmark from which new
behavioral economics considers deviations may itself be evolving.
Starting with the final arrival of new behavioral economics, this paper
has offered a historical perspective on the content and timing of the cur-
rent enthusiasm for behavioral economics. In addition, by documenting
the transition from the diversity of old behavioral economics to the rel-
ative uniformity of new behavioral economics, it has shown how histor-
ical analysis may contribute to a possible revival of abandoned research
Sent / Behavioral Economics 755
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... One of the main characteristics of the works of Herbert Simon (e.g., 1955) was criticism of the standard approach to economic rationality in his employment of psychological insights. Simon's bounded rationality theory is considered to be one of the foundations of the old behavioral economics (Frantz 2020;Kao and Velupillai 2015;Sent 2004). The rise of new behavioral economics began with Kahneman and Tversky's (1979;Tversky and Kahneman 1986) pioneering research questioning the empirical validity of neoclassical economic rationality as expressed in expected utility theory (Heukelom 2014). ...
... Camerer and Loewenstein are also eager to emphasize that their work 'does not imply a wholesale rejection of the neoclassical approach to economics ' (2004, p. 3). The same view is held by other major figures in new behavioral economics, such as Richard Thaler and Matthew Rabin (Kao and Velupillai 2015;Sent 2004). Hence, this is the main explanation for the wider acceptance of new behavioral economics among mainstream theorists (see, for instance, Chetty 2015). ...
Τhe idea that social influences and social interactions play a central role in individual economic decisions has had a long presence in the history of economics. With the emergence of marginalism, this idea retreated into the background and the concept of the atomistic individual became established in mainstream economic rationality. Starting in the 1970s, there were some attempts to reintroduce non-atomistic preferences in mainstream microeconomic theory in the form of social interactions, interdependent preferences, keeping up with the Joneses, social identity, social preferences, and status concerns. Social preferences have a growing impact among mainstream microeconomics with the advent of behavioral economics, but still they are not in the hard core of the standard theory of choice. The article argues that atomistic preferences are still prevalent, especially in the form of the assumption of the representative agent. It also focuses on the role of methodological individualism and on the theoretical implications of relaxing the assumption of the atomistic individual as the main explanations for the resilience of the notion.
... Illiashenko (2017) eme régi elméletről, "a behaviorizmusról" azt mondja, hogy e megközelítés felemelkedése vált a pszichológiától való "menekülés" fő útvonalává a közgazdászok számára, és a pszichológiának az emberi természetre vonatkozó feltevéseitől való eltávolodáshoz. A 20. század elején a neoklasszikus közgazdaságtan -ahelyett, hogy teljességgel elutasította volna a pszichológiát -inkább azt választja, hogy a megfigyelhető viselkedéssel foglalkozó behaviorizmusra (Sent, 2004) alapozza a választást. ...
Cikkünk annak igazolását tűzte ki célul, hogy a viselkedési szál búvópatakként mindenkor jelen volt a közgazdaságtanban, és a viselkedési közgazdaságtan elméletének megformálása elsősorban nem paradigmaváltást idézett elő a várható hasznosság maximalizálás alapvetésével szemben, hanem a döntéselmélet és a gyakorlati döntéshozatal előrelendítése volt a legfontosabb eredménye. A cikk kiindul a várható hasznosság maximalizációjának elvéből, majd tisztázza a viselkedési tényező eredetét a közgazdaságtanban. A várhatóhasznosság-elméletének kritikája után szó van a pszichológiamentes közgazdaságtan megalapozására irányuló törekvésekről. A szubjektív valószínűség meghatározó szerepének bemutatása központi helyet foglal el a gondolatmenetben. A cikk kitér a viselkedési közgazdaságtan és a viselkedési pénzügyek döntéshozatali szerepének méltatására.
... Calling Richard Cyert, James March, Herbert Simon the "old behavioral economists, who focused on bounded rationality, satisficing, and simulations" (p. 740), historian of economics Esther-Mirjam Sent (2004) explained the transition from Old to New Behavioral Economics (pp. 742 -747), thus: "The roots of new behavioral economics may be traced to the 1970s and the work of especially Amos Tversky and Daniel Kahneman,…" (p. ...
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Over the past decades psychological theories have made significant headway into economics, culminating in the 2002 (partially) and 2017 Nobel prizes awarded for work in the field of Behavioural Economics. Many of the insights imported from psychology into economics share a common trait: the presumption that decision makers use shortcuts that lead to deviations from rational behaviour (the Heuristics-and-Biases program). Many economists seem unaware that this viewpoint has long been contested in cognitive psychology. Proponents of an alternative program (the Ecological-Rationality program) argue that heuristics need not be irrational, particularly when judged relative to characteristics of the environment. We sketch out the historical context of the antagonism between these two research programs and then review more recent work in the Ecological-Rationality tradition. While the heuristics-and-biases program is, via Behavioural Economics, now well-established in (mainstream neo-classical) economics, we show there is considerable scope for the Ecological-Rationality program to interact with economics. In fact, we argue that there are many existing, yet overlooked, bridges between the two, based on independently derived research in economics that can be construed as being aligned with the tradition of the Ecological-Rationality program. We close the chapter with a discussion of the open challenges and difficulties of integrating the Ecological Rationality program with economics.
... Hence it is not surprising that it continues to be ignored within mainstream economics. It is also not surprising that those whose work was the focus of Dow's paper-namely, practitioners of what Sent (2004) has called New Behavioural Economics (NBE)-are also oblivious of it, for they tend not to have received training in what Sent calls Old Behavioural 2 Economics (OBE) or in the modern evolutionary economics that morphed out of OBE via contributions such Winter's (1964) paper. ...
... 15. While an extensive discussion exceeds the scope of this paper, it is useful to note the distinction between the 'old' behavioral economics of George Katona and Herbert Simon whose work on bounded rationality emphasized how cognitive limitations contradict the neoclassical conception of rationality, and the 'new' behavioral economics of Amos Tversky and Daniel Kahneman (Sent, 2004). 16. ...
Considering Kuhn’s emphasis on the community structure of science, this paper focuses on the scientific community to inquire whether the recent global financial crisis ushered paradigm change in economics. To appraise the nature and the extent of post-crisis change, we examine the methodological constitution of the dominant paradigm identified as New Consensus Macroeconomics, methodological commitments binding paradigm and scientific community, and assess the practice of the community, particularly the treatment of anomalies. Subsequently, an attempt is made to illuminate whether/how sociological and institutional parameters in the community structure of the discipline bear upon prospects of change. Empirically, this research investigates, categorizes and evaluates post-crisis responses and perceptions of the scientific community. The overarching aim is to determine whether economics responded to a major anomaly with critical self-reflection on the adequacy of its methodological toolbox, leading to theory change, and to shed light on institutional aspects influence this process.
... In the second half of the twentieth century, an increasing number of scholars was motivated by a dissatisfaction with the unrealistic assumptions of microeconomics and a conviction to put forth descriptively more accurate models of individual choice using insights from cognitive psychology (Sent 2004). The most prominent spokesman of this 'old school' of behavioral economics was Herbert Simon as illustrated by his prolific work on bounded rationality (Simon 1955(Simon , 1956(Simon , 1959. ...
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This article discusses the role of methodological individualism in behavioral economics. Since behavioral economics developed in reaction to traditional microeconomics, the chapter sketches first the latter's understanding of methodological individualism. It argues that traditional microeconomics is based on three principles: the self-interest principle, the rationality principle, and the social change principle. The article then discusses experimental findings that led behavioral economists to relax all three principles. It argues that in particular the relaxation of the social change principle pushes the boundaries of methodological individualism since it highlights ways in which social institutions, norms, and rules affect individual processes of preference formation. In doing so, behavioral economics invites intricate discussions of the bi-directional relationship between social institutions and individual actions.
Behavioral economics is developing very fast in the Western countries nowadays. Initially behavioral economics tried to answer the question of whether human behavior in decision-making corresponds to the neoclassical model, which emphasizes the consistency and logic of human behavior. As a result of numerous experiments in this direction, the limitation of the neoclassical model of human behavior was proved. And the conclusions drawn by supporters of behavioral economics have made it possible to look differently at some provisions of market radicalism (fundamentalism). Behavioral economics contributes to neoclassical theory in this direction, but tries to add more realistic psychological foundations to the analysis. For example, one of the most famous behavioral economists, K. Camarer, wrote in his study: “Behavioral economics is based on the belief that increasing the reality of psychological foundations in economic analysis will improve economic theory on its own, providing an opportunity to penetrate essence (processes), make better predictions about real phenomena and propose better policies” [1, с. 3]. Thus, behavioral economics aims to supplement existing knowledge about economic phenomena, applying the achievements of modern psychology, sociology, neurophysiology. One of the first stages in the formation of behavioral economics can be considered the concept of G. Simon, who suggested that man in making decisions can not be completely rational, at least because he can not always make the necessary calculations. A person makes a decision by choosing the option that seems most acceptable, but this option is not always optimal. But long before Herbert Simon, many economists studied human subjectivity in economic decision-making. Such studies can be found in the works of Adam Smith, William Stanley Jevons, David Ricardo, Carl Menger, Leon Walras and others. Many of the ideas of these authors, which they came to by reasoning, eventually received logical psychological evidence. Considering all of the above, we can say that the role of behavioral economics in economic theory and the analysis of the ways of its development are very relevant.
Thomas Kuhn's The Structure of Scientific Revolutions offers an insightful and engaging theory of science that speaks to scholars across many disciplines. Though initially widely misunderstood, it had a profound impact on the way intellectuals and educated laypeople thought about science. K. Brad Wray traces the influences on Kuhn as he wrote Structure, including his 'Aristotle epiphany', his interactions, and his studies of the history of chemistry. Wray then considers the impact of Structure on the social sciences, on the history of science, and on the philosophy of science, where the problem of theory change has set the terms of contemporary realism/anti-realism debates. He examines Kuhn's frustrations with the Strong Programme sociologists' appropriations of his views, and debunks several popular claims about what influenced Kuhn as he wrote Structure. His book is a rich and comprehensive assessment of one of the most influential works in the modern sciences.
This book is unique among modern contributions to behavioral economics in presenting a grand synthesis between the kind of behavioral economics popularized by Richard Thaler, earlier approaches such as those of the 1978 Nobel Laureate Herbert Simon, evolutionary psychology, and evolutionary economics from Veblen and Marshall through to neo-Schumpeterian thinking. The synthesis employs a complex adaptive systems approach to how people think, the lifestyles they build, and how new production technologies and products are gradually adopted and produce changes. Using a huge range of examples, it takes behavioral economics from its recent focus on 'nudging' consumers, to the behavior of firms and other organizations, the challenges of achieving structural change and transitioning to environmentally sustainable lifestyles, and instability of the financial system. This book will be of great interest to academics and graduate students who seek a broader view of what behavioral economics is and what it might become.
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This paper mainly discusses the availability heuristic in behavioral economics. This article mainly introduces the definition and significance of Availability heuristic, as well as three examples of its impact on the economic sphere of everyday life from different aspects. These are real estate, transportation, and stocks. Because availability heuristic is one of the ways the human brain works, it’s hard for any of us to avoid making wrong choices because of it. It will appear in all aspects of our lives, affecting not only personal development, but also economic life from various angles. Therefore, the research purpose of this paper is to let more people know availability heuristic in rational thinking and learn to use it to make more rationally and correct choices.
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Behavioral economics uses evidence from psychology and other disciplines to create models of limits on rationality, willpower and self-interest, and explore their implications in economic aggregates. This paper reviews the basic themes of behavioral economics: Sensitivity of revealed preferences to descriptions of goods and procedures; generalizations of models of choice over risk, ambiguity, and time; fairness and reciprocity; non-Bayesian judgment; and stochastic equilibrium and learning. A central issue is what happens in equilibrium when agents are imperfect but heterogeneous; sometimes firms “repair” limits through sorting, but profit-maximizing firms can also exploit limits of consumers. Frontiers of research are careful formal theorizing about psychology and studies with field data. Neuroeconomics extends the psychological data use to inform theorizing to include details of neural circuitry. It is likely to support rational choice theory in some cases, to buttress behavioral economics in some cases, and to suggest different constructs as well.
This book is an examination of the nature of economic explanation. The opening chapters introduce current thinking in the philosophy of science and review the literature on methodology. Professor Blaug then turns to the troublesome question of the logical status of welfare economics, giving the reader an understanding of the outstanding issues in the methodology of economics. This is followed by a series of case studies of leading economic controversies, which shows how controversies in economics may be illuminated by paying attention to questions of methodology. A final chapter draws the strands together and gives the author's view of what is wrong with modern economics. This book is a revised and updated edition of a classic work on the methodology of economics, in which Professor Blaug develops his discussion of the latest developments in macroeconomics, general equilibrium theory and international trade theory. A new section on the rationality postulate is also added.
Celebrating the 150th anniversary of Cournot's work, which Mark Blaug has characterized as 'a book that for sheer originality and boldness of conception has no equal in the history of economics thought', this volume focuses on the properties and uses of Cournot's model of competition among the few. While there are many issues that Cournot explored in researches into the mathematical principles of the theory of wealth, the topic that he is most readily associated with - and which now is also enjoying a revival - is his model of oligopolistic interaction among firms. This revival of interest in Cournot's model is due largely to increased emphasis by economists on capturing elements of imperfect competition and strategic behavior.
The connection of economic theory and behavior is one of the central topics of this book - and also a central issue in economic thinking of Horst Todt to whom this book is dedicated. The contributions deal with topics of normative and descriptive decision-making: They investigate, for instance, the emergence of decisions or the role of imitation as a competitive principle. A number of contributions treat special decision-making problems on a micro or on a macro level, whereas others concentrate on the principle questions of decision-making or on the conceptualization of important but fuzzy notions like power or solidarity.
Much recent work in the economics of information has stemmed from the observation that demand functions, and therefore prices, reflect agents’ private information. Given an adequate understanding of the relationship between private information and equilibrium prices, it is possible to infer some or all of the private information. It seems natural to suppose, therefore, that agents will endeavour to use the information contained in equilibrium prices.