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Is Behavioral Economics Doomed?

Is Behavioral Economics Doomed?: The Ordinary versus the Extraordinary

David K. Levine
Copyright Date: 2012
Published by: Open Book Publishers
Pages: 143
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  • Book Info
    Is Behavioral Economics Doomed?
    Book Description:

    It is fashionable to criticize economic theory for focusing too much on rationality and ignoring the imperfect and emotional way in which real economic decisions are reached. All of us facing the global economic crisis wonder just how rational economic men and women can be. Behavioral economics—an effort to incorporate psychological ideas into economics—has become all the rage. This book by well-known economist David K. Levine questions the idea that behavioral economics is the answer to economic problems. It explores the successes and failures of contemporary economics both inside and outside the laboratory. It then asks whether popular behavioral theories of psychological biases are solutions to the failures. It not only provides an overview of popular behavioral theories and their history, but also gives the reader the tools for scrutinizing them. Levine’s book is essential reading for students and teachers of economic theory and anyone interested in the psychology of economics.

    eISBN: 978-1-906924-94-2
    Subjects: Economics

Table of Contents

  1. 1. Introduction
    (pp. 1-4)

    Even Max Weber – one of the early proponents of the social analysis of rational man – recognized the essential irrationality of emotions such as love. Today it has become so very fashionable to criticize economic theory for focusing too much on rationality and ignoring the imperfect and emotional way in which decisions are reached in the “real world.” Psychologists and other social scientists have been especially vocal in their dismay. A bright new group of behavioral economists has picked up the criticism:

    Economics traditionally conceptualizes a world populated by calculating, unemotional maximizers that have been dubbed Homo economicus. The...

  2. 2. Does Economic Theory Work?
    (pp. 5-20)

    It is impossible to have an intelligent discussion of economics, of game theory, or of behavioral economics – let alone their successes and failures – without some idea of what they are about.Homo economicusis a far different creature than commonly imagined. Let us begin by examining this mythical construct more closely.

    The heart of modern “rational” economic theory is the concept of a non-cooperative or “Nash” equilibrium of a game. If you saw the movieA Beautiful Mindthis theory – created by Nobel Laureate John Nash – is briefly described, albeit inaccurately. But to put the oxen...

  3. 3. Why Is the World so Irrational?
    (pp. 21-46)

    One of the most frustrating experiences for a working economist is to be confronted by a psychologist, political scientist – or even in some cases Nobel Prize winning economist – to be told in no uncertain terms “Your theory does not explain X – but X happens in the real world, so your theory is wrong.” The frustration revolves around the fact that the theory does predict X and you personally published a paper in a major journal showing exactly that. One cannot intelligently criticize – no matter what one’s credentials – what one does not understand. We have just...

  4. 4. Does Economic Theory Fail?
    (pp. 47-62)

    Economic theory works some of the time. But perhaps not always? There is an experimental literature that argues there are gross violations of economic theory. Since these failures are not with the theory of Nash equilibrium, I will explain an important variation – the notion of subgame perfect equilibrium. How well does the theory of subgame perfection do in the laboratory? In three games – a public goods game called Best-shot, a bargaining game called Ultimatum and the game of Grab-a-dollar the simple theory with selfish players fails.

    Our notion of a game is a matrix game in which players...

  5. 5. You Can Fool Some of the People…
    (pp. 63-76)

    What can economic theory reasonably hope to say? Any model is an idealization in which many things that are thought to be relatively unimportant are ignored: decision costs, social preferences, costs of acquiring information, and so forth and so on. Moreover in applied work it is necessary to adopt specific mathematical functions which are at best approximations to an underlying reality. A caricature ofhomo economicusasserts that in the laboratory everyone is selfish and that all the participants understood the instructions. Or more strongly that all students always get all exam questions correct – the falsity of which even...

  6. 6. Behavioral Theories I: Biases and Irrationality
    (pp. 77-92)

    Economic theory has its weaknesses: the theory of approximate Nash equilibrium may be “correct” but it doesn’t always yield strong predictions. Understanding the psychological elements that predominate when economic incentives are weak – understanding the “epsilons” – would be of great value to economics. So you might think that behavioral economics carefully searches through the psychology literature to identify ideas that would help remedy these weaknesses. You would not suppose that behavioral economics was an attempt to remake those areas of economics that are strong and well studied. Nor would you suppose that behavioral economics was an effort to put...

  7. 7. Behavioral Theories II: Time and Uncertainty
    (pp. 93-110)

    The previous chapter discussed various irrationalities and biases alleged by behavioral economists. Much of the work in behavioral economics, however, has focused on the elements of time and uncertainty. Unlike the biases of the previous chapter – which generally attack issues that are not of great interest to economists – time and uncertainty lie at the very heart of modern economics. So let us examine these topics from the behavioral point of view.

    One distinguished critic of “standard economics” is David Laibson of Harvard who had drawn the profession’s attention to the phenomenon known aspresent bias. As an example,...

  8. 8. Learning and Friends
    (pp. 111-122)

    Do economists blindly assume that people are rational and have rational expectations? Ironically the notion of rational expectations that is widely attacked by non-economists as unrealistic is the least obnoxious of the assumptions about beliefs that economists make. The notion that would be attacked if the attackers had any idea what they were talking about is the idea ofcommon knowledge. Common knowledge asserts that not only do I know what you are going to do and you know what I am going to do – but that I know that you know what I am going to do, and...

  9. 9. Conclusion: Psychology, Neuroscience and Economics
    (pp. 123-130)

    Economics is commonly condemned for favoring rigor and mathematics over relevance. Perhaps apocryphally the economist Kenneth Boulding is quoted as having said “Mathematics brought rigor to Economics. Unfortunately, it also brought mortis.” In 1973 Wassily Leontief in his Nobel Prize lecture – apparently a popular forum for criticizing economics – said

    Page after page of professional economic journals are filled with mathematical formulas leading the reader from sets of more or less plausible but entirely arbitrary assumptions to precisely stated but irrelevant theoretical conclusions.

    Much more recently the historian of economic thought, Mark Blaug, said

    Economics was condemned a century...