Is Homo Economicus becoming extinct?


Term Paper, 2012

21 Pages, Grade: 1,2


Excerpt

Content

1. Introduction

2. Behavioral Economics
2.1 History
2.2 Definition
2.3 Experimental Economics and Neuroeconomics

3. Neoclassical Economics
3.1 Advantages of the Standard Economic Model
3.2 Criticism

4. Behavioral Economic Model
4.1 Principle 1: People are influenced by Other’s Behavior
4.1.1 Herding
4.1.2 Social Proof
4.2 Principle 2: Habits are important
4.2.1 Status Quo Bias
4.3 Principle 3: People can act altruistically
4.3.1 The Ultimatum Game
4.4 Principle 4: People’s Self-Expectations influence Behavior
4.4.1 Cognitive Dissonance
4.5 Principle 5: People are loss-averse
4.5.1 Endowment-Effect
4.5.2 Sunk-Cost Effect
4.6 Principle 6: People are bad at Computation when making Decisions
4.6.1 Salience
4.6.2 Hyperbolic Discounting
4.6.3 Framing
4.6.4 Intuition
4.7 Principle 7: People need to feel involved and effective to make a Change
4.7.1 Illusion of Control
4.7.2 Hindsight Bias
4.8 Résumé

5. Conclusion

6. Bibliography

7. Internet Sources

1. Introduction

In his famous article “A Behavioral Model of Rational Choice” from 1955, Herbert Simon already called the concept of the Homo Economicus into question and explained:

“The concept of “economic man” is in need of fairly drastic revision. […] The task is to replace the global rationality of economic man with a kind of rational behavior that is compatible with the access to information and the computational capacities that are actually possessed by organisms exist. One is tempted to turn to the literature of psychology for the answer.”[1]

There existed many economists sharing Simon’s opinion at that time. Nonetheless until recent years the majority of economists were extremely skeptical about psychological-based approaches in economics, in particular due to the believed lacking of universality and the low mathematical formalism.

Since 2002 this attitude has been changing, when Daniel Kahneman and Veron Smith awarded the Nobel Prize in economics for their work in the field of behavioral economics and experimental economics. Nowadays there are many economists and psychologist around the world dedicating to this new area of economics. As more success has been achieved, behavioral economics have become a more respectable field with a variety of journals publishing relevant research.

“Economics today is at an exciting stage of evolution, as it begins to reopen routes of interchange with other disciplines. In this interdisciplinary exchange, psychology stands closer to center-stage than most other disciplines. It has provided the grist for challenging many standard economic assumptions and catalyzed the rapidly growing fields of behavioral economics and experimental economics.”[2]

Against a background of these recent developments, I had the idea to this term paper. In the following, I will present detailed information about behavioral economics. Throughout this work I will also make comparisons between the standard economic model and various theories that relate to behavioral economics with regard to my research assignment: Is Homo Economicus becoming extinct?

2. Behavioral Economics

Most of the ideas in behavioral economics are not new, indeed, they return to the roots of neoclassical economics after a century-long detour. When economics first became identified as a distinct field of study, psychology did not exist as a discipline. Many economists moonlighted as the psychologists of their times.

2.1 History

Although Adam Smith, the father of economics, is best known for his work “The Wealth of Nations”, in 1776, he was also the author of a less well known work, “The Theory of Moral Sentiments”, in 1759. The latter work contains a number of vital psychological insights and foreshadows many more recent developments in behavioral economics, particularly relating to the role of emotions in decision-making.[3]

Similarly, Jeremy Betham, best known for introducing the concept of utility, had much to say about the underlying psychology of consumers. Francis Edgeworth wrote “The Theory of Mathematical Psychics” in 1881, the title indicating his concern with psychology; this is reflected in his well-known “Edgeworth Box”, which relates to two-person bargaining situations and involves a simple model of social utility. “However, psychology was in its infancy at this time as an academic discipline, and many economists wanted the also-new science of economics to have a surer and more rigorous grounding, similar to that of natural sciences.”[4] Hence sprang the neoclassical revolution, and the birth of the concept of Homo Economicus, that rational self-interested utility maximize.

In the first half of the twentieth century there were still economists who considered and discussed psychological factors in their work, for example Irving Fisher, Vilfredo Pareto, and John Maynard Keynes. However, the general trend during this time was to ignore psychology.

This trend continued after the Second World War, aided in many ways by the advent of better computational methods. “Economists became obsessed with […] the measurement of variables, and the estimation of economic parameters using mathematical equations and econometric methods.”[5] More progress was made in terms of theoretical development, and the emphasis on mathematical treatment led to greater rigor and more precise, if not accurate, results.

Some heretics, like the mentioned Herbert Simon, viewed this approach as somewhat blinkered. He believed it important to understand the underlying motivation behind the behavior of economic agents in order to improve existing theories and make more accurate predictions. Simon introduced the term “bounded rationality” to refer to the cognitive limitations facing decision-makers in terms of acquiring and processing information.[6]

There were a number of seminal papers written in the 1950s and 1960s, which complemented the work of Simon. It was at the end of 1970s that behavioral economics was born. Two papers were largely responsible for this. The first in 1979 was entitles “Prospect Theory: An Analysis of Decision under Risk” and was written by two psychologists, Daniel Kahneman and Amos Tversky, being published in the economic journal “Econometrica”. The second paper, “Toward a Positive Theory of Consumer Choice”, was published by the economist Richard Thaler in 1980. In particular he introduced the concept of “mental accounting”, closely related to the concepts of Kahneman and Tversky.

Since 1980 the field of behavioral economics has become a burgeoning one, as both economists and psychologists have expanded and developed the work of the pioneers mentioned above.

2.2 Definition

Despite this burgeoning of publications, behavioral economics has not yet reached the “normal science” stage in its development as a research program. Precisely defining what behavioral economics is, and what it can achieve, are questions to which there are as yet no commonly, accepted answers. Nevertheless Mullainathan and Thaler formulated a wide but adequate definition:

“Behavioral Economics is the combination of psychology and economics that investigates what happens in markets in which some of the agents display human limitations and complications.”[7]

This definition comprises the two most important characteristics of behavioral economics. On the one hand, this statement stresses that behavioral economics combine economics and psychology, using theories from both fields of study. Major sources, however, are cognitive psychology, social psychology and experimental economic research. On the other hand, the definition assumes the concept of man whose acting and thinking are imposed restrictions unlike the neoclassical theory does.

2.3 Experimental Economics and Neuroeconomics

Apart from behavioral economics, experimental economics and neuroeconomics are also relatively new fields of study, taking off in the 1980s. These three areas of economics are all closely linked as there are significant overlaps between them.

The field of experimental economics was largely pioneered by Veron Smith, who “believed that economics could be enriched by experimental methods that would not only lend insight into psychological processes, but also enable a tighter control over the relevant variables in order to come to more specific and reliable conclusions than it is often possible with conventional observational studies.”[8]

Neuroeconomics refers to the use of empirical evidence relating to brain activity in order to come to conclusions relating to economic behavior.”[9] It has been made possible by a number of recent technological developments, particularly in terms of brain scanning etc. The findings are especially relevant in terms of decision-making heuristics, learning processes, and the role of emotions.

3. Neoclassical Economics

The standard (neoclassical) economic analysis assumes that humans are rational and behave in a way to maximize their individual self-interest. It postulates an “economic man” who, is in the course of being “economic” is also “rational”. This man is assumed to have knowledge of the relevant aspects of his environment which, if not absolutely complete, is at least impressively clear and voluminous. “He is assumed also to have well-organized and stable system of preferences, and a skill in computation that enables him to calculate, for the alternative courses of action that are available to him, which of these will permit him to reach the highest attainable point on his preference scale.”[10] “Neoclassical economics dominates microeconomics, and together with Keynesian economics forms the neoclassical synthesis, which dominates mainstream economics today.”[11]

3.1 Advantages of the Standard Economic Model

The neoclassical approach is useful because it provides economists with a theoretical framework that can be applied to almost any form of economic (and even non-economic) behavior. The reasons why economists use the Homo Economicus is because it makes economic analysis simpler. In real life, accurately predicting or explaining human behavior is extremely difficult. To simplify this task, economists simplify the human being. Moreover, such simplifications allow economists to make their discipline more mathematical. If humans are “rational maximizers”, then it is possible to describe their preferences numerically.

3.2 Criticism

Behavioral economists have raised great doubts as to whether this schematized model of economic man provides a suitable foundation on which to erect a theory. Thorstein Veblen sardonically stated that neoclassical economics assumes a person to be “a lightning calculator of pleasures and pains, who oscillates like a homogeneous globule of desire of happiness under the impulse of stimuli that shift about the area, but leave him intact.”[12]

4. Behavioral Economic Model

According to behavioral economics, the “rational man” has many shortfalls that can lead to unrealistic economic analysis and policy-making. In the list below, one can find seven key principles highlighting the main shortfalls in the neoclassical model of human behavior.

1. People are influenced by Other’s Behavior
2. Habits are important
3. People can act altruistically
4. People’s Self-Expectations influence Behavior
5. People are loss-averse
6. People are bad at Computation when making Decisions
7. People need to feel involved and effective to make a Change

In the following pages these principles are described in more detail. The theory is contrasted with that of neoclassical economics and finally further illustrative models from psychology are given.

[...]


[1] Simon, page 99

[2] Agarwal/Vercelli, page 53

[3] cf. Wilkinson, page 11

[4] Wilkinson, page 11

[5] Ibidem

[6] cf. Tisdell, page 30

[7] Mullainthan/Thaler, page 1

[8] Wilkinson, page 13

[9] Ibidem

[10] Simon, page 239

[11] http://en.wikipedia.org/wiki/Neoclassical_economics

[12] Ibidem

Excerpt out of 21 pages

Details

Title
Is Homo Economicus becoming extinct?
College
University of Applied Sciences Bremen
Grade
1,2
Author
Year
2012
Pages
21
Catalog Number
V195282
ISBN (eBook)
9783656211532
ISBN (Book)
9783656212102
File size
672 KB
Language
English
Tags
homo, economicus
Quote paper
Jessica Witzel (Author), 2012, Is Homo Economicus becoming extinct?, Munich, GRIN Verlag, https://www.grin.com/document/195282

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