March 26, 2006

Behavioral economics

I recently read an article on the Harvard Journal, called The Marketplace Of Perceptions. The author, Craig Lambert, has written a very interesting essay on Behavourial Economics. Rather, it is an effort to try to explain the issues which cannot be explained by traditional economics.

The rational model only approximates human cognition—“just as Newtonian physics is an approximation to Einstein’s physics,” Laibson explains. “Although there are differences, when walking along the surface of this planet, you’ll never encounter them. If I want to build a bridge, pass a car, or hit a baseball, Newtonian physics will suffice. But the psychologists said, ‘No, it’s not sufficient, we’re not just playing around at the margins, making small change. There are big behavioral regularities that include things like imperfect self-control and social preferences, as opposed to pure selfishness. We care about people outside our families and give up resources to help them—those affected by Hurricane Katrina, for example.”

“When the same thing sells at two different prices in different markets, forces of arbitrage and rationality are necessarily limited,” Shleifer says. “The forces of irrationality are likely to have a big impact on prices, even on a long-term basis. This is a theoretical attack on the central conventional premise.”
Behavioral economics, which can be used to explain the unanswered phenomenon, is the hybrid offspring of economics and psychology. It tries to explain why we want chocolate, cigarettes, and a trashy movie now, but in the future, we want to eat fruit, to quit smoking, and to watch Bergman films.

Further he talks about 'prescriptive economics', which aims not only to describe the world but to change it, then about pre-commitments, its fallacies and how to make it work. He goes the full circle from an African woman's cahbox to SEED from Phillipines to Social Security privatization. He explains how framing the questions has a much greater effect on the eventual choice than is expected by traditional economics, on how a woman's photograph on the application form turns out to be as important as a drop in the intrest rate by five points.

Eventually, he uses the logic contained in the complete write up to find reasons for the supply of hatred amongst men and about persuation, about why "George W. Bush wearing a $3,000 cowboy hat was not a problem, because it matched his image, but John Kerry riding a $6,000 bicycle was a problem, which was that luxury item appeared hypocritical for a candidate claiming to side with the downtrodden." Or Cognitive Persuation, as Andrei Shleifer calls it.

A beautiful essay, and interesting even for us non-economists.