Behavioral

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"People tend to be happy when they live up to how they think they should be; and they are, correspondingly, unhappy when they fail to live up to those norms." George Akerlof

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An Introduction to Economic Theory Before the Behavioral Approach: The Keynesian Approach

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In his 2006 speech, "The Missing Motivation in Macroeconomics," George Akerlof, a Nobel Prize-winning economist, challenges some ideas about macroeconomics that were established by the well-respected John Maynard Keynes.

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History of Behavioral Economics

Behavioral economics began when scientific research on cognitive decisions and human emotions was used to give economist a deeper understanding of economic decisions. Using psychology and economic theories economists can create behavioral models.

The Classical Period (1776)

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Adam Smith (1723-1790)

“How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortunes of others, and render their happiness necessary to him, though he derives nothing from it, except the pleasure of seeing it” –Adam Smith

He is most famous for publishing The Theory of Moral Sentiments and An Inquiry into the Nature and Causes of the Wealth of Nations

His studies concentrated in the philosophy, psychology, and ethics behind economics. He divided the moral system into two main groups. The first was the nature of morality which included propriety, prudence, and benevilance. The second group was the motive of morality which included self-love, reason, and sentiment.

Jeremy Bentham (1748-1832)

Jeremy Bentham is known for his studies in utility and decision making. He came up with the idea that pleasure and pain can be organized by dimension, which is their intensity or duration. He focused on the maximization principles behind the economics of consumers, firms, and creating balances between the two. He also studied the relevance of forced saving, propensity to consume, the saving-investment relationship. These studies have formed our modern ideas of income and how employees and employeers work together.

Neo-classical period (1871)

Economics separated from psychology and was being reshaped into a natural science.

During this period there were still economists who used psychological explanations in their analyses.

Examples include:

Francis Edgeworth (1845-1926)

Vilfredo Pareto (1848-1923)

Irving Fisher (1964-1963)

John Maynard Keynes (1883-1946)

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20th century

This period is characterized by psychologist beginning research on parts of the brain that are responsible for decision making and began to relate it to economic models and how risk and uncertainty affect behavior.

Important People During the 20th century

• Ward Edwards
• Amos Tversky
• Daniel Kahneman

In 1979, Kahneman and Tversky wrote a paper called “Prospect theory: Decision Making Under Risk”. They used cognitive psychological techniques to explain economic decision making from neo-classical theory. They discussed how it is possible for econmic decisions to go two different ways.

In 2002 Daniel Kahneman was awarded the Nobel prize for combining psychology and economics to study human judgement and decision-making abilities under uncertainty.

Richard Herrnstein (1930-1991)

Published The Bell Curve

has done work on humans and animals to support his idea that behavior is not based on expected utility or previous reinforcement. He is best known for publishing the Melioration theory and Matching Law.

The Matching Law:

(R1 and R2 are rates of response for two alternative responses, and r1 and r2 are rates of reinforcement for the same two responses)

The five neutralities discussed by Akerlof are:

• Ricardian equivalence

• The independence of consumption and current income

• The independence of investment and finance decisions

• Inflation stability only at the natural rate of unemployment

• The ineffectiveness of macro-stabilization policy with rational expectations

• Discussion Questions

• Conclusion

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Bibliography Akerlof, George A. "The Missing Motivation in Macroeconomics". [1]