Economic Psychology

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Economic Psychology

How and why markets aren't rational. Navigational tips for charting the Bermuda Triangle of human economic behavior.




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Looking Back, Looking Forward
 
I started this blog on December 19, 2002 - with a post entitled Episode one, where I decide to take the plunge. When I did so, I don't even think I knew that just two months beforehand, psychologists Daniel Kahneman and Amos Tversky (Tverky, posthumously), as well as experimental economist Vernon Smith, had just won the Nobel Prize in Economics, for the former's (empirical) work on judgment and decision making, and the latter's use of experimental methods to test economic hypotheses.

From the Nobel organization's press release announcing the award:
Traditionally, economic theory has relied on the assumption of a "homo œconomicus", whose behavior is governed by self-interest and who is capable of rational decision-making. Economics has also been regarded as a non-experimental science, where researchers – as in astronomy or meteorology – have had to rely exclusively on field data, that is, direct observations of the real world. During the last two decades, however, these views have undergone a transformation. Controlled laboratory experiments have emerged as a vital component of economic research and, in certain instances, experimental results have shown that basic postulates in economic theory should be modified. This process has been generated by researchers in two areas: cognitive psychologists who have studied human judgment and decision-making, and experimental economists who have tested economic models in the laboratory.
The breakthroughs recognized by the judges were twofold:
  1. Establishing, based on empirical evidence, that the assumption underlying western Economics (that human economic decisions are rational, focused entirely on self interest and the best available information) was tightly-bounded-to-baseless.

  2. That economic hypotheses can and should be tested using rigorous, empirical methods - rather than relying on external, existing measures, whose construct, content, and external validity had never been established.
I still think experimental economics has a very long way to go before it achieves an acceptable level of psychometric integrity (by which I mean: the test items measure what they intend to measure, do so consistently across time, space, and groups involved), but Vernon put the field on a path whereby such integrity is at least achievable.

Kahneman and Tversky - through careful, empirical, valid and reliable research - did the world a great service by demonstrating to a skeptical academic public that which anyone with reasonable powers of observation should have already noticed: people rarely, if ever, make economic decisions on a primarily rational basis.

In the next few posts, I'll discuss some of the ways in which Behavioral Economics/Economic Psychology (BE/EP) and blogging have changed since that day in 2002 when I decided to "take the plunge" - and my views thereof.