Belief: The economy is navigated by human beings who are imperfect participants; therefore creating a dynamic, complex and uncertain path.
Policy recommendation: To effectively manage the economy, we must first understand the relationship between human psychology with money, markets and the economy.
Behavioural economics posits that psychological, cognitive, emotional and social factors affect the economic decisions of individuals and institutions. Since this school of thought concerns the bounds of rationality of economic agents, it stretches across many fields and concepts.
Behavioural economics represents a major challenge to Neoclassical economics. Neoclassical economics reshaped economic thinking into a scientific method whereby economic models and behaviour must be built on underlying assumptions. It also stressed that all individuals act rationally and think the same, the famous concept of homo economicus. However, behavioural economics stabs at the heart of Neoclassical economics as it attacks the assumption that all individuals act rationally.
An example of a behavioural observation is Prospect theory. This posits that, when making decisions involving risk, agents will favour choices which present gains rather than losses, even if those choices amount to the same outcome. For example, faced with the following choices:
A) be given £100 with a 90% chance of keeping it, or
B) be given £100 with a 10% chance of losing it;
most people will choose A even though the outcome is, probabilistically, the same as B.
But, behavioural economics has also come under scrutiny. The Neoclassical school defend their assumption of the rational individual by arguing that competitive markets force agents to act rationally and that experimentally observed behaviour outside the bounds of rationality are only that, experimentally observed.
– Robert Sugden
– Daniel Kanerman
– Amos Tversky
– Prospect theory
– Bounded rationality
– Hyperbolic discounting