Why is it important for economists to study psychology
In conventional economics it is assumed that we are all rational — meaning that the decisions we make are the perfect decision for us. How do we achieve this feat? What standard economics assumes is that every time we face a choice we consider all the available options, compute the value of all the options, perform a cost benefit analysis, and then follow the best possible path of action. What if we make a mistake and do something irrational? Here, too, traditional economics has an answer: “market forces” will sweep down on us and swiftly set us back on the path of righteousness and rationality.
But, what if we are really far less rational than standard economic theory assumes. What if we can’t compute the discounted value of money, consider all the possible options, or figure out how much a new car is really worth to us? Shouldn’t our models of individual behavior, and more importantly our recommendations for new policies and practices, be based on what people actually do rather than what they are supposed to be doing?
The desire to base the models that guide policies and business practice on the way people actually behave seem to make intuitive sense, but nevertheless, behavior is largely ignored by standard economics. And what are the implications of this for economics? As the economist, John Maurice Clark noted many years ago:
“The economist may attempt to ignore psychology, but it is sheer impossibility for him to ignore human nature… If the economist borrows his conception of man from the psychologist, his constructive work may have some chance of remaining purely economic in character. But if he does not, he will not thereby avoid psychology. Rather, he will force himself to make his own, and it will be bad psychology.”
This is what behavioral economics is all about. The desire to modify standard economics to take behavior into account. To move it away from naive psychology (which often fails the tests of reason, introspection, and-most importantly-empirical scrutiny), and turn it into a study that encompasses the complexity of human behavior, and more importantly making it better suited to make recommendations that would help saving, education, healthcare etc.
Hello Professor Ariely, I heard about your book during a WNYC broadcast a month or so ago and am looking forward to its release.
Your post reminds me of an article I read recently in the LA Times in which the behavior shown in two economic studies was described as “weird and irrational”. That made me wonder about the traditional definition of rationality. Just because some decisions don’t add up in terms of real monetary value, does it mean that economic principles of utility cannot still apply? What about non-monetary utility? When I am choosing between brands of cotton balls at the pharmacy, it may not make dollar sense to buy the brand name when the near identical generic brand is much cheaper, but the utility I associate with the brand name also adds value to the decision-making process. When we figure that non-monetary utility into our utility maximization considerations, that seemingly irrational decision may be rational after all.
My day-dreaming-from-work rumination is, I suppose, that utility maximization is still relevant in analyzing “irrational” decisions, but that because of the unique nature of preferences, it can only explain decision-making on an individual basis. Describing these non-monetary behaviors in terms of psychology provides more opportunity for aggregate analysis without the need to define the util-value associated with decision factors, but there persists the issue of a difference in units of analysis. How can psychological analysis be combined with economic analysis when the units of analysis differ?
I suppose those are some of the questions that make me so curious to read your book. Hopefully my recent graduate salary will allow me to rationally purchase it once it is released!
Dear Professor Ariely,
Does psychology help us model only individual economic behavior or can it be (or has been) used to model mass or group behavior?
Malcolm Gladwell’s the Tipping Point, presented some interesting examples about how few key players can cause exponential following for a product or an idea. Has such behavior been modeled in economics?
thanks
Hello, Professor Ariely.
I’m looking forward to reading your book. This website is already very nice, I’m slowly going through your papers and they’re fascinating.
I am at this moment reading a good and well written book, that happens to have opposite observations on human behaviors. It’s ‘The Logic of Life’, by Tim Hartford. The author tries to uncover hidden logic and rationality beneath all kinds of situations, and states that our decision process, even in seemingly unrational situations is driven by weighing incentives. I wonder if you are familiar with the book. And if so, do you have a particular view you would like to share?
Best regards and success with your new book,
Saulo Ribas
Hi Saulo,
Like you I found ‘The Logic of Life’, by Tim Hartford to be a terrific book.
It is true that the two books are from opposite perspectives, but this does not mean that they are not complimentary. The Logic of Life is about the behaviors that are governed by economic forces, while Predictably Irrational is about the behaviors that are irrational. Unless you believe that al behaviors are fully and always rational (or irrational), this means that there are some cases where we behave according to economic principles and some in which we are not.
Personally, I think that the economic lens is a fantastic perspective on life, but it is not compete and we need to consider other things as well when we try to understand human nature.
I heard glimpses of you on Radio 4 this morning and it was very interesting. It would be good to be able to budget time in the same way as money.
By the way, if you would like feedback on the door game, it was not obvious to me that I was allowed to click on an open door a second time, which skews the results if this is only discovered in the second test.
In the instructions, you might like to explain that a person can choose to either click on the same door again, or select an alternative door.
I like the second test too, although, if I may say, the question should not be, “Which test should you spend more time?” but, “Which test should you spend less time?”
By spending only a third of the time making decisions, my score rose by more than 50%. (It is not beneficial to spend time on the similar times, and even making mistakes on teh dissimilar trials is OK, if selections are made rapidly – affected by the number of points available per selection.
Is this helpful?