Neuroeconomics

John Cassidy has a wonderful New Yorker essay on what neuroeconomists do, new insights the subject might offer us about our economic behaviour and decisions, how it might make mainstream economics revisit some of its rather restrictive assumptions, and what the detractors of neuroeconomics have to say about its techniques.

Here’s a two paragraph summary of the need for behavioural economics:

In 1979, two Israeli psychologists, Daniel Kahneman and Amos Tversky, published a paper in the economics journal Econometrica, describing the concept of loss aversion. At the time, few economists and psychologists talked to one another. In the nineteenth century, their fields had been considered closely related branches of the “moral sciences.” But psychology evolved into an empirical discipline, grounded in close observation of human behavior, while economics became increasingly theoretical—in some ways it resembled a branch of mathematics. Many economists regarded psychology with suspicion, but their preference for abstract models of human behavior came at a cost.

In order to depict economic decisions mathematically, economists needed to assume that human behavior is both rational and predictable. They imagined a representative human, Homo economicus, endowed with consistent preferences, stable moods, and an enviable ability to make only rational decisions. This sleight of hand yielded some theories that had genuine predictive value, but economists were obliged to exclude from their analyses many phenomena that didn’t fit the rational-actor framework, such as stock-market bubbles, drug addiction, and compulsive shopping. Economists continue to study Homo economicus, but many recognize his limitations. Over the past twenty-five years, using methods and insights borrowed from psychology, they have devised a new approach to studying decision-making: behavioral economics.

Here’s a framing of the ‘new new thing’ in economics by one of its practitioners. I like to call it ‘glory by association‘:

“Natural science has moved ahead by studying progressively smaller units,” [Harvard’s David Laibson said]. “Physicists started out studying the stars, then they looked at objects, molecules, atoms, subatomic particles, and so on. My sense is that economics is going to follow the same path. Forty years ago, it was mainly about large-scale phenomena, like inflation and unemployment. More recently, there has been a lot of focus on individual decision-making. I think the time has now come to go beyond the individual and look at the inputs to individual decision-making. That is what we do in neuroeconomics.”

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See also this recent post titled Is economics the new physics?.

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