One of the most off-putting things about the economics discipline is how, despite its centrality in human affairs, there is a clear absence of human touch. There are rigid charts, equations and models to explain complex, real-life experiences.
Take for instance volatility in the stock market. That can be attributed to people’s fears and uncertain expectations about the future.
But this integral element of human behavior seems to be disregarded in coursework. In fact, it even relies on the assumption that decision-making is always rational. That assumption is curious because we all have experienced the power of emotions.
So, in reality, economic decision-making is like any other decision-making process — irrational. Irrationality isn’t just some outlier, it needs to be accounted for.
It’s actually pretty fair that economics was dubbed “the dismal science.” Anyways, this observation is likely what prompted Richard Thaler, a University of Chicago professor, to create behavioral economics. In a nutshell, behavioral economics uses the lens of human psychology in order to analyze and then to make sense of decision-making.
Recently, this particular branch of economics has become incredibly popular, and the Wharton School of the University of Pennsylvania even dedicated an entire undergraduate program to it. In fact, even a New York Times article is calling it a “triumph of marketing.”
However, this triumph casts a dark shadow over University of Illinois at Chicago professor David Gal’s analysis of its popularity among the general public.
In essence, Gal, who authored the Times article, argues the subject’s mainstream popularity is obstructing behavioral economists’ progress on explaining human behavior.
I disagree. First and foremost, the discipline definitely combines psychology’s intuition with economics’ practicality. That is not merely a marketing tactic meant to attract conflicted college freshmen — it is the very foundation upon which the discipline was built.
Furthermore, of course behavioral economists are trying to demonstrate the distinctions between their models and more conventional ones. Behavioral economics, compared to other disciplines within economics, is new and lacks clout.
Rectifying that by emphasizing the unique qualities that Thaler made note of isn’t an instance of insecurity and becoming sidetracked. Rather, it is a necessity to pad behavioral economics’ growth.
Another interesting point the Gal makes is that a central finding in behavioral econ, “loss aversion,” is too simplistic. Loss aversion suggests losses have a larger psychological effect than gains do. Because of this “psychological glitch,” humans make a lot of puzzling decisions.
Based on my own experience, this glitch seems to hold true. However, this article argues behaviors attributed to “loss aversion” are better explained by other factors.
One such factor is “inertia,” or the notion that since people don’t have a defined understanding of what an item means to them, there is a discrepancy between individuals’ valuation of the exact same item in buying and selling circumstances.
While inertia is a logical factor, the notion that losses hurt our psyches more than gains help would make more sense to the average person since it’s common knowledge that we tend to value things we have less than things we’ve lost.
Take, for instance, diminishing marginal returns. This law demonstrates how after maximum productivity, an additional worker or machine results in a smaller increase in output. While it is still performing well, the firm’s management would probably be alarmed by the slowdown rather than impressed by the absolute gain in production.
Recently, U.S. stocks dropped despite a healthy economy. Why? Speculation is driven by fear, and that can result in irrational behavior. Even real-life circumstances reinforce the conventional take on loss aversion.
Perhaps it’s because opponents to behavioral economics are coming from a conventional scientific background that loss aversion and other behavioral economic concepts seem highly questionable.
However, credit should be given where credit is due. One cannot refute that factoring in real human behavior into economics makes it significantly more appealing to the average person than classical economics.
It also improves the accuracy of a highly theoretical discipline — a problem many of my Questrom School of Business peers seem to have many issues with.
