Posts Tagged ‘Richard Thaler’

Richard Thaler Wins the Nobel Prize for Economics in 2017

November 15, 2017

Assiduous readers of the Healthymemory blog should recognize the name from previous healthy memory blog posts. Richard Thaler is a behavioral economist. Early in his career he met up with the psychologists Amos Tversky and Daniel Kahneman. Amos Tversky and Daniel Kahneman formulated Prospect Theory. Most economic models are normative. That is they describe what a rational human should do if behaving optimally. Prospect Theory explained what people actually do. The theory states that people make decisions based on the potential value of losses and gains rather than the final outcome, and that people evaluate these losses and gains using certain heuristics. The model is descriptive: it describes what people actually do. Kahneman won a Nobel Prize in 2002 primarily for Prospect Theory. Unfortunately Amos Tversky had passed away and was not eligible for the prize.

Prospect Theory was the beginning of behavioral economics. In addition to describing how people actually behave in the economic realm, it develops techniques to nudge people in making good decisions. For example, making what is regarded as the best decision in a list of alternatives the default decision greatly increases the number of people who choose that option. For example, if making deductions for a pension is the default decision, that is the option most likely to be chosen.

Although it is good to know what the theoretical optimal decisions are, if the interest is in public policy, it is important to know what people will actually do. The field of behavioral economics is still young and there is much to be done. But they are working on how best to understand what people will do to better understand how to influence them to make decisions that will benefit them, individually, and society as a whole.

© Douglas Griffith and, 2017. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited. Excerpts and links may be used, provided that full and clear credit is given to Douglas Griffith and with appropriate and specific direction to the original content.

Behavioral Economics

August 29, 2015

A number of previous healthy memory blog posts have been on the topic of behavioral economics. Mainstream economics is based on the idea of the rational man.  In 1978 the psychologist Herbert Simon was awarded the Nobel Prize in Economic Science for his research showing that human beings do not, and often cannot, evaluate all available information before making a decision.  He found that people satisfice, that is, use only enough information they think they need to make a decision.  In 2002, the psychologist Daniel Kahneman shared the Nobel Prize in Economic Science for his work with Amos Tversky showing the relevance of psychological research on human judgment and decision making under uncertainty to economics.  Kahneman and Tversky formulated Prospect Theory that showed how human behavior deviated from the economic norm.  Unfortunately, Tversky had passed away, so he was ineligible to receive the Nobel Prize.

Misbehaving:  The Making of Behavioral Economics by Richard H. Thaler provides a well-written and informative discussion of the development of behavioral economics.  Although he is an economist he had the good fortune to be able to work with Kahneman and Tversky early in his career.  So he was an early, perhaps the earliest, economist to come into the behavioral economics fold.  The book unfolds in chronological order so you are able to follow the development of Thaler’s career along with the development of behavioral economics.  His writing is quite entertaining.

Misbehaving: The Making of Behavioral Economics covers the course of the development of behavioral economics up until current times, so the coverage of material is quite large. The book begins with the discussion of SIFs (supposedly irrelevant factors).  These are factors that classical economics wave off as being irrelevant, but which are most certainly not irrelevant.  Early in his career Thaler began making his list of phenomena which were relevant to economics, but which were waved off as being irrelevant.  There are two types of theories:  normative and descriptive.  Normative theories inform us the right way to think about some problem.  Right here refers logical consistency.  Descriptive theories explain how problems are handled.  That is, what people actually do.  This differences is central to the difference between classical and behavioral economics.  Classical economics explains how logically people should be  behave, and behavioral economics explains how people actually do behave.

Perhaps the most dramatic example of this distinction can be found in the recent economic crash.  According to the rational model of man, this crisis should not have happened.  And, indeed, it was predicted by very few economists.   The crisis was due to the irrational, emotional nature of human beings.  The economics Alan Greenspan had a sign reading “Greed is Good” on his door.  Greed is also one of the Seven Deadly Sins.  I remember thinking that adjustable rate mortgages were a big mistake.  People tend to be overly optimistic and often overlook misfortune in their future.  This combined with increases in interests rates could cause many too default on their mortgages.  I had no idea of the extent of shenanigans  that were taking place.  Optimism regarding the never ending increase in real estate values precluded any rationality or safeguards.  Unfortunately, the changes in financial regulation were woefully inadequate, and another market crash looms in the future.  That is unless more attention is paid to behavioral economics and appropriate legislation is passed.  Unfortunately, although the influence of behavioral economics has grown, I was pleased to learn that Thaler had been elected President of the American Economics Association, it has yet to become mainstream.  Until it does, we remain at risk as the rational model of humanity is flawed.  Economics needs to be based on what humans do, not on a theoretical model based on rationality.

Misbehaving: The Making of Behavioral Economics is a real gem.  Unfortunately it presents me with a real dilemma.  I could easily spend several months writing posts based on this book.  However, I fear that some readers would not appreciate the emphasis being placed on economics and become bored.  Moreover, focusing on Thaler’s book would force me to neglect some needed topics.  So, what I shall do is to occasionally reach back to this book for posts that seem especially relevant.

© Douglas Griffith and, 2015. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited. Excerpts and links may be used, provided that full and clear credit is given to Douglas Griffith and with appropriate and specific direction to the original content.