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Behavioral economics

Behavioral economics studies the effects of psychological, cognitive, emotional, cultural and social factors on the economic decisions of individuals and institutions and how those decisions vary from those implied by classical theory.[1]

In 2002, psychologist Daniel Kahneman was awarded the Nobel Memorial Prize in Economic Sciences 'for having integrated insights from psychological research into economic science, especially concerning human judgment and decision-making under uncertainty'.[5]

In 2017, economist Richard Thaler was awarded the Nobel Memorial Prize in Economic Sciences for 'his contributions to behavioral economics and his pioneering work in establishing that people are predictably irrational in ways that defy economic theory'.[7][8]

Then, during the development of neo-classical economics, economists sought to reshape the discipline as a natural science, deducing behavior from assumptions about the nature of economic agents.

Expected utility and discounted utility models began to gain acceptance, generating testable hypotheses about decision-making given uncertainty and intertemporal consumption, respectively.

Observed and repeatable anomalies eventually challenged those hypotheses, and further steps were taken by Maurice Allais, for example, in setting out the Allais paradox, a decision problem he first presented in 1953 that contradicts the expected utility hypothesis.

Simon used the analogy of a pair of scissors, where one blade represents human cognitive limitations and the other the 'structures of the environment', illustrating how minds compensate for limited resources by exploiting known structural regularity in the environment.[15]

A widely cited proposal from Sunstein and Thaler urges that healthier food be placed at sight level in order to increase the likelihood that a person will opt for that choice instead of less healthy option.

These include backward bending labor supply curves, asymmetric price elasticities, tax evasion and co-movement of stock prices and consumption.

a special behavioral economics edition of the Quarterly Journal of Economics ('In Memory of Amos Tversky'), and Kahneman's 2002 Nobel Prize for having 'integrated insights from psychological research into economic science, especially concerning human judgment and decision-making under uncertainty'.[23]

This pattern of discounting is dynamically inconsistent (or time-inconsistent), and therefore inconsistent with basic models of rational choice, since the rate of discount between time t and t+1 will be low at time t-1 when t is the near future, but high at time t when t is the present and time t+1 is the near future.

This pattern can also be explained through models of sub-additive discounting that distinguish the delay and interval of discounting: people are less patient (per-time-unit) over shorter intervals regardless of when they occur.

The work on 'intrinsic motivation by Gneezy and Rustichini and 'identity' by Akerlof and Kranton assumes that agents derive utility from adopting personal and social norms in addition to conditional expected utility.

According to Aggarwal, in addition to behavioral deviations from rational equilibrium, markets are also likely to suffer from lagged responses, search costs, externalities of the commons, and other frictions making it difficult to disentangle behavioral effects in market behavior.[24]

'Conditional expected utility' is a form of reasoning where the individual has an illusion of control, and calculates the probabilities of external events and hence their utility as a function of their own action, even when they have no causal ability to affect those external events.[25][26]

The Silicon Valley-based start-up Singularities is using the AGM postulates proposed by Alchourrón, Gärdenfors, and Makinson—the formalization of the concepts of beliefs and change for rational entities—in a symbolic logic to create a 'machine learning and deduction engine that uses the latest data science and big data algorithms in order to generate the content and conditional rules (counterfactuals) that capture customer's behaviors and beliefs'.[29]

From a biological point of view, human behaviors are essentially the same during crises accompanied by stock market crashes and during bubble growth when share prices exceed historic highs.

During those periods, most market participants see something new for themselves, and this inevitably induces a stress response in them with accompanying changes in their endocrine profiles and motivations.

Awareness of indirect consequence (or lack of), at least in potential with different experimental models and methods, can be used as well—behavioral economics' potential uses are broad, but its reliability needs scrutiny.

Examples provided on this account include pillars of behavioral economics such as satisficing behavior or prospect theory, which are confronted from the neoclassical perspective of utility maximization and expected utility theory.

Others note that cognitive theories, such as prospect theory, are models of decision-making, not generalized economic behavior, and are only applicable to the sort of once-off decision problems presented to experiment participants or survey respondents.[citation needed]

David Gal has argued that many of these issues stem from behavioral economics being too concerned with understanding how behavior deviates from standard economic models rather than with understanding why people behave the way they do.

Some economists see a fundamental schism between experimental economics and behavioral economics, but prominent behavioral and experimental economists tend to share techniques and approaches in answering common questions.

Nudge is a concept in behavioral science, political theory and economics which proposes positive reinforcement and indirect suggestions as ways to influence the behavior and decision making of groups or individuals.

nudge, as we will use the term, is any aspect of the choice architecture that alters people's behavior in a predictable way without forbidding any options or significantly changing their economic incentives.

An example of such a nudge is switching the placement of junk food in a store, so that fruit and other healthy options are located next to the cash register, while junk food is relocated to another part of the store.[44]

Tammy Boyce, from public health foundation The King's Fund, has said: 'We need to move away from short-term, politically motivated initiatives such as the 'nudging people' idea, which is not based on any good evidence and doesn't help people make long-term behaviour changes.'[53]

Other key observations include the asymmetry between decisions to acquire or keep resources, known as the 'bird in the bush' paradox, and loss aversion, the unwillingness to let go of a valued possession.

Experimental finance applies the experimental method, e.g., creating an artificial market through some kind of simulation software to study people's decision-making process and behavior in financial markets.

They contend that behavioral finance is more a collection of anomalies than a true branch of finance and that these anomalies are either quickly priced out of the market or explained by appealing to market microstructure arguments.

It is argued that the cause is entry barriers (both practical and psychological) and that returns between stocks and bonds should equalize as electronic resources open up the stock market to more traders.[76]

Although such studies are set up primarily in an operant conditioning chamber using food rewards for pecking/bar-pressing behavior, the researchers describe pecking and bar-pressing not in terms of reinforcement and stimulus-response relationships but instead in terms of work, demand, budget, and labor.

Recent studies have adopted a slightly different approach, taking a more evolutionary perspective, comparing economic behavior of humans to a species of non-human primate, the capuchin monkey.[94]

Space considerations do not permit a detailed discussion of the reasons why economists should take seriously the investigation of economic theories using nonhuman subjects....[Studies of economic behavior in non-human animals] provide a laboratory for identifying, testing, and better understanding general laws of economic behavior.

Use of this laboratory is predicated on the fact that behavior, as well as structure, vary continuously across species, and that principles of economic behavior would be unique among behavioral principles if they did not apply, with some variation, of course, to the behavior of nonhumans.

The pigeons are then placed in an operant conditioning chamber and through orienting and exploring the environment of the chamber they discover that by pecking a small disk located on one side of the chamber, food is delivered to them.

The value of the currency can be adjusted in several ways, including the amount of food delivered, the rate of food delivery and the type of food delivered (some foods are more desirable than others).

Specifically, in an operant conditioning chamber containing rats as experimental subjects, we require them to press a bar, instead of pecking a small disk, to receive a reward.

Under these circumstances, the researchers claim that changing the number of bar presses required to obtain a commodity item is analogous to changing the price of a commodity item in human economics.[97]

In effect, results of demand studies in non-human animals show that, as the bar-pressing requirement (cost) increase, the number of times an animal presses the bar equal to or greater than the bar-pressing requirement (payment) decreases.

An evolutionary psychology perspective states that many of the perceived limitations in rational choice can be explained as being rational in the context of maximizing biological fitness in the ancestral environment, but not necessarily in the current one.

Ethically Aligned Design, First Edition (EAD1e) | IEEE

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