Behavioral economics: A methodological note

When a theory faces a set of facts that are not compatible with its key assumptions, there are several ways it might respond. In response to the challenge posed by behavioral economics, neoclassical economics has attempted numerous different approaches. After briefly reviewing these responses, this paper turns to argue in favor of one of them. 2009 Elsevier B.V. All rights reserved. When a theory faces facts that are not compatible with its key assumptions, there are several options concerning the ways it might respond. All of these are being applied in response to the challenge posed by behavioral economics (BE) to neoclassical economics. After briefly reviewing these responses, I turn to argue in favor of one of them. One response is to treat BE findings as marginal. Tim Harford, writing in the Financial Times, reports that many economists hold that BE ‘‘merely illuminates some fascinating but relatively minor foibles”. He adds that he has ‘‘long been persuaded that the evidence shows that we are fundamentally rational creatures when it comes to most decisions that really matter” (2008). Many of the key findings of BE are, however, are difficult to minimize because they show that people have congenital cognitive limitations evident in numerous choice situations. Several economists argue that even if many individuals act in ways which seem to conflict with the rational, utility-maximizing assumptions – in aggregate, they act as if theywere optimizers. For instance,GaryBecker argues: ‘‘It doesn’tmatter if 90%of people can’t do the complex analysis required to calculate probabilities. The 10% of people who can, will end up in the jobs where it’s required” (quoted Stewart, 2005). Becker however provides no data to demonstrate that 10% (or even 1%) of economic actors are optimizers, or that the markets in aggregate act rationally, as opposed to, for instance, gyrating between periods of irrational exuberance and greed, and irrational fear and panic (Shiller, 2005). A different response relaxes the criteria that define rationality. This response takes several forms: 0167-4870/$ see front matter 2009 Elsevier B.V. All rights reserved. doi:10.1016/j.joep.2009.09.004 * Tel.: +1 202 994 8190; fax: +1 202 994 1606. E-mail address: [email protected]. Journal of Economic Psychology 31 (2010) 51–54