Is Behavior Economics Good Economics?

Recently, a relatively new economics called Behavioral Economics (BE) has started to gain popularity. Its practitioners such as Daniel Kahneman, Vernon Smith and Richard Thaler were awarded Nobel prizes for their contribution in the field of BE.

The BE framework emerged on account of dissatisfaction with the neo-classical theory regarding consumer choices. A major problem with the neo-classical theory that people presented as if a scale of preferences is hard-wired in their heads. Regardless of anything else, this scale remains the same all the time.

The practitioners of BE hold that this is a very unrealistic case. Hence, to make the mainstream framework more realistic they suggested introducing psychology into economics.

It is held that people’s emotional state is going to influence their decision-making process. Thus, if consumers are becoming more optimistic regarding the future then this is going to be an important message to businesses regarding their investment decisions.

According to BE researchers whether consumers are generally patient or impatient determines whether or not they are inclined to spend or save today. If they are more patient and save more, then this can generate funds for entrepreneurs’ new investment projects.

Behavioral economists emphasize the importance of personality. An emphatic person is regarded more likely to make altruistic choices. Impulsive people are more likely to be impatient and not so good at saving up for their retirement. Venturesome people are more likely to take risks — they will be more likely to gamble (see Michelle Baddeley’s Behavioural Economics. A Very Short Introduction).

While the BE criticism of mainstream economics is valid, the question arises whether BE solves the issue of unchanged consumer preferences and presents consumers as real people and not as human machines.

The key here is the definition of what human beings are all about. According to BE, people are not rational in a sense that they are using reason in various decisions. According to BE practitioners, the key driver for consumer choices are emotions. For instance, the Nobel Laureate Vernon Smith holds,

People like to believe that good decision making is a consequence of the use of reason, and that any influence that the emotions might have is antithetical to good decisions. What is not appreciated by Mises and others who similarly rely on the primacy of reason in the theory of choice is the constructive role that the emotions play in human action.1

Obviously once the importance of reason is dismissed, what is then left is treating human beings like objects. According to this way of thinking, human action is not navigated by reason but by outside factors that act upon men. By means of a given stimulus, one can then observe various human reactions and draw all sorts of conclusions regarding the world of economics. According to Mises however,

It is impossible to describe any human action if one does not refer to the meaning the actor sees in the stimulus as well as in the end his response is aiming at.2

By rejecting the importance of the human reason, behavioral and experimental economists treat man as another animal. In fact, some of the experimental economists are conducting various experiments on pigeons and rats in order to verify various propositions of mainstream economics.3

Why the introduction of psychology in economics will not make economics more realistic