Number 2023 Psychology and the Market by Edward L . Glaeser December 2003 Harvard University Cambridge , Massachusetts

Prospect theory, loss aversion, mental accounts, hyperbolic discounting, cues, and the endowment effect can all be seen as examples of situationalism— the view that people isolate decisions and overweight immediate aspects of the situation relative to longer term concerns. But outside of the laboratory, emotionally-powerful situational factors— frames, social influence, mental accounts— are almost always endogenous and often the result of self-interested entrepreneurs. As such, laboratory work and, indeed, psychology more generally, gives us little guidance as to market outcomes. Economics provides a stronger basis for understanding the supply of emotionally-relevant situational variables. Paradoxically, the rise of situationalism actually increases the relative importance of economics. * I am particularly grateful for conversations with Gary Becker, Daniel Benjamin, Drew Fudenberg, David Laibson, Richard Posner, Jesse Shapiro, Andrei Shleifer and Richard Zeckhauser. Paul Romer particularly influenced my thinking in this area.