Behavoral Economics: The Gounds

Economists have preferences; psychologists have attitudes."

by Daniel Kahneman, 1998

Recently, to better understand how people make mode choice in search for a more effective and efficient counteraction against congestion and polllution, I've read a deal of articles about behaviors and found some interesting issues and arguments between economists and psychologists (one of the best is here, the University of Chicago Magazine). One of the most famous points in the arguments (Nobel Laureate Prof. Daniel Kahneman's well-quoted and classical paper, prospect theory), is that, however, human beings are not fully rational beings. When under uncertainty they make decision according to how they feel their wealth or state is going to change by it, and they choose it based on whether it is being considered as a gain or loss. I am so glad that I am able to indulge in those great works done by some of the most insightful and intelligent social scientists, economists, and psychologists. While it seems that prospect theory and other behavioral thoughts are against traditional economic maxims (people are able to make the best decision out from a number of choices which turn out to maximize their utility), I am viewing it as a valuable supplement to what constitutes human beings' decision making mechanism.

In my heart of hearts, I am convinced by yet another dedicated Nobel Laureate Herbert Simon (who coined the term "bounded rationality"). He noted in the New Palgrave Dictionary of Economics. Simon argued that “the phrase ‘behavioral economics’ appears to be a pleonasm,” or redundancy: “What non-behavioral economics can we contrast it with? The answer to this question is found in the specific assumptions about human behavior that are made in neoclassical economic theory.” I also see no difference between the two. In the fundamentals of microeconomic theory, people choose the best bundle of goods they can afford. This is, of course, an obvious psychological assumption about people's decision-making process. In 2005, another absolutely must-read paper reviewing another less known book by Father of Economics - Adam Smith - The Theory of Moral Sentiments, has suggested that the book, which was written 17 years earlier before The Wealth of Nations, presaged many developments in behaviroal economics we are seeing today. In the classical book, Smith gave many bone-chilling examples about how human beings act. For instance,

What are the pangs of a mother, when she hears the moanings of her infant, that, during the agony of disease, cannot express what it feels? In her idea of what it suffers, she joins, to its real helplessness, her own consciousness of that helplessness, and her own terrors for the unknown consequences of its disorder; and out of all these, forms, for her own sorrow, the most complete image of misery and distress. The infant, however, feels only the uneasiness of the present instant, which can never be great.

The authors of the review paper (Ashraf et al.) has suggested that, "Smith adds dryly that 'we sympathize even with the dead', who themselves experience nothing." It is absolutely a careful and original observation of people's behavior. Given Adam Smith's less prevalent part of wisdom, Prof. Camerer, the other authors of the review paper suggested that the recent fashion of behavioral economics is in fact, a “return to the roots of neoclassical economics after a century-long detour.”

In some cases, the behavioral side tends to suggest that limiting people's choice set especially when they are not well-informed or motivated could be a better policy direction (not by government intervention, but by some smart people who can design the BEST solution for all individuals). From my point of view, however, better solution shouldn't be defined by a relatively-small group of smart people and I believe it won't always do good things for people. The real question here is, therefore, what kind of choice are we talking about? If it's a decision involved no collective or social impact, then maybe it'd better not to limit people's choice simply because economists and scholars think they will make silly decisions. On the other hand, if it's a decision associated with significant externalities, in which situation not only each individual's welfare, but also misery are interconnected, then some form of libertarian paternalism will be much more legitimate and reasonable.