Economics and Psychology

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Bounded rationality: psychology, economics and the financial crisis

Bounded rationality: psychology, economics and the financial crisis

During the fifties there have been important explorations along the boundaries between economics and psychology. In particular, experimental psychology, concerned with the study of actual behavior and aware of the complexity of choices, had highlighted the systematic (and unconscious) divergence of human behavior from the postulates of economic rationality. Then some economists using experimental results questioned the validity of the classical model of rational choice (Simon, 1959). Thus a new line of research, called behavioral economics, started to be developed, trying to relate psychological factors to economic behavior. One important contribution came from Herbert Simon's approach, that developed the notion of bounded rationality and the problem solving. Bounded rationality, in particular, depends – according to Simon (1972) – on the limits of attentive and computational capacity. Thus, he gave start to an approach based on the heuristics, that are interpreted as a trade-off between the limits of the human mind and the computing performance required by complex problems. Simon’s concept of bounded rationality can be interpreted – according to Kahneman (2003) – as defining a realistic normative standard for an organism with a finite mind. Simon essentially criticized – on the basis of analysis conducted on the field – the lack of realism of the neoclassical economic theory based on the assumption of full rationality. Another major contribution came from the pioneering experimental studies of Allais (1953), which have given a boost to the cognitive economic approach. Allais’ studies demonstrated that preferences of individuals violate expected utility theory, so he proved the systematic discrepancy between the predictions of traditional decision theory and actual behavior. The results of laboratory experiments conducted by Allais have shown that individuals chose inconsistently and that they preferred solutions which did not maximize the expected utility. In this way Allais have demonstrated that the axiomatic definition of rationality did not allow to describe and even predict economic decisions 4 .
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Reconciling economics and psychology on intrinsic motivation

Reconciling economics and psychology on intrinsic motivation

shown that economic models are interested in the income effect induced by a permanent reward, during its supply; on the other hand, psychology investigates the intertemporal substitution effect of a temporary reward in the post reward period. Therefore, similarities and differences among results proposed by economists and psychologists can be explained by adopting an intertemporal framework. Moreover, when economics searches for the perverse effects of incentives, it cannot invoke empirical results from psychology, usually related to a substitution effect. Dealing with income effects, economic analyses should concentrate on whether the free choice activity is considered by individuals to be an inferior good.
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Economics and psychology Perfect rationality versus bounded rationality

Economics and psychology Perfect rationality versus bounded rationality

Simon’s work has been followed in the research on judgment and decision making, both in economics and psychology. Two major approaches produced important insights into perception mechanisms shaping the individual’s internal representation of the problem: the ‘‘heuristics and biases” program (Tversky, Kahneman, 1974), which has been fundamental to the contemporary development of behavioral economics. Tversky and Kahneman, in fact, offer a theoretical explanation about the observed deviations from perfect rationality, noting that people rely on “ heuristic principles which reduce the complex tasks of assessing probabilities and predicting values to simpler judgmental operations” (1974, p.1124). They therefore do not abandon the assumption that individuals are intelligent and intentional in making decisions, but they assume systematic and specific biases that move away the judgement from the perfect rationality of individuals. Moreover, accordin to Kahneman and Thaler (2006) to accept a model where individuals maximize their utility function, which by hypothesis is perceived to be consistent, accurate and also stable over time, is not possible anymore, because individuals often make systematic errors in predicting their future experience and results, thus failing to maximize their utility. This occurs because individuals in acting face real difficulty in assessing their preferences and, therefore, prefer the pursuit of instant gratification, which, however, are often inconsistent with their long-term preferences (Rabin, 1998). The "failures" of perfect rationality depend also on the specific ways in which people select and process the information mentally. The attitude to risk of the individual varies depending on frame within which lies the choice (Kahneman and Tversky, 1979). In fact, Kahneman and Tversky with their ‘Prospect theory’ have shown experimentally the presence of inconsistent judgments and choices by an individual facing the same problem presented in different frames (‘invariance of failures’). It follows that the frame, or the context of choice, ceteris paribus, helps to determine a different behavior. Among the violations of the expected utility paradigm, that have a psychological motivation and which are important in the financial choices, in particular there are the risk aversion and, above all, the loss aversion (Kahneman and Tversky, 1984) 3 . Kahneman and Tversky have shown, for example, that many of the risks of little importance is given disproportionate weight, but also that the losses and future earnings are not treated symmetrically.
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The Relationship between Psychology and Economics: Insights from the History of Economic Thought

The Relationship between Psychology and Economics: Insights from the History of Economic Thought

The issue of the relationship between economics and psychology effectively contains two central points which are the following: 1) To what extent do economic assumptions need to be based on sound psychology, and 2) the possibility of independence of economics from psychology (Lewin, 1996; Camerer and Loewenstein, 2004, Frey and Benz, 2004 ). It is clear that these two points also exhibit a strong historical and methodological bend. Thus and in order to get further insights to the above, a substantial part of the relevant literature is focused on the history of the relationship between economics and psychology. The bulk of this literature deals with the relation between economics and psychology after the marginalist revolution. In particular, the strive of late marginalist/neoclassical economics to expel psychology from economic theory (Pareto, Slutsky, Hicks, Allen, Samuelson) is a well-researched topic (e.g. Hands, 2010). Given the recent discussion of re-introducing psychological elements in economics mainly in the context of behavioral economics, other papers focus on the history of behavioral economics since WWII. In general, most of the research concentrates to the period that followed the marginalist revolution and only mentions briefly the historical developments before that period (see for instance, Angner and Loewenstein, 2012; Nagatsu, 2015; Earl, 2016). Thus, there is a considerable gap which lies on the earlier ideas on the role of psychology in economics. In fact, for many pre-marginalist major authors, the issue of incorporating psychological elements in economic discourse was also an important theme. There are many such examples in the works of Whately, Banfield, Lloyd, and Gossen. More detailed discussion and arguments can also be found in the economic thought of Senior and Jennings.
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Economics and psychology  The framing of decisions

Economics and psychology The framing of decisions

II) why and how their behavior does not follow the predictions of (mainstream) economic models. Daniel Kahneman, who won the Nobel Prize in Economics in 2002, in his Nobel Lecture “Maps of Bounded Rationality: A Perspective on Intuitive Judgment and Choice” follows a line of human reasoning different from pure rationality and proposes an innovative approach with his development of the dual-process account of reasoning. Kahneman’s line of thought is based on the distinction between the process of deliberate reasoning, that is a controlled mode, which is slower, and that of intuition in which judgments and decisions are made automatically. In other words, in a first approximation, “intuition” denotes a mental activity largely automatized and inaccessible from conscious mental activity.
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Defining and measuring blood donor altruism: a theoretical approach from biology, economics and psychology

Defining and measuring blood donor altruism: a theoretical approach from biology, economics and psychology

altruistic act [4] and (2) altruism is the most common self-reported motive for blood donation [5]. However, while altruism reflects a number of related theoretical processes (e.g. reciprocity, warm glow) identified in psy- chology [6], economics [7] and evolutionary biology [8, 9], in blood donor researcher, it is typically assessed as a single construct. Moreover, generic altruism-based slo- gans, such as ‘Do something amazing: save a life. Give blood’, do not reflect these processes, and therefore, the motivational focus of recruitment campaigns may not match donor motives [10, 11]. The main aim of this study, therefore, is to develop more substantive, theoretically informed multidimensional index of blood donors’ altruistic motivations.
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Statistical Fallacy: A Menace to the Field of Science

Statistical Fallacy: A Menace to the Field of Science

It also revealed that Statistics students have a higher mean score in their understanding about statistical concepts. This indicates that the students who major in statistics have a less chance of committing statistical fallacy during data collection, analysis and interpretation. The test of significance showed a statistical significant difference between students in the four departments namely; Statistics, Banking/Finance, Economics and Psychology which is because of the high score margin of the Statistics students. It also shows that there is no significant difference between Economics, Banking/Finance and Psychology Students in their conception about statistical concepts. Studying statistical concepts and techniques reduces misconception. Previous researchers added that for one to apply any statistical method correctly, sound understanding is required because it seems to be especially sensitive to be misunderstood (John & David, 2002; Kirk, 2001; Zaidan & Ismail, 2012) and statistical techniques cannot be used blindly (Midi et al, 2007).
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Terrorism, identity, psychology and defence economics

Terrorism, identity, psychology and defence economics

Akerlof and Kranton (2000, p.715) define identity as an individual’s sense of self. The definition is usually linked with some social category (such as gender) or group. It is appropriate to think of a ‘social identity’ as: “The individual’s knowledge that he or she belongs to certain social groups together with some emotional and value significance to him or her of group membership. Put another way, social identity is self-conception as a group member” (Abrams and Hogg 1990). Identity has long been recognised by psychologists as being of significant relevance to understanding terrorism and terrorist behaviour. In his review of the psychological approaches to the analysis of terrorism, Victoroff (2005) lists multiple examples where identity (or related concepts) occupies a prominent place in the analysis of terrorist behaviour, often in explaining ‘motivations’ rather than ‘payoffs’. Rather than draw a dividing line between economics and psychology on this point, it is possible to learn more about identity and its role in explaining terrorism by exploring how identity or self image considerations shape the terrorist’s ‘payoffs’. Once established, this bridge from psychological to economic analysis can be traversed in the opposite direction with insights about the importance of identity and self image obtained from examining their effect on ‘payoffs’ to actions enhancing the analysis of identity and self image as motivational factors for terrorism. The implication, of course, is that such possibilities extend beyond identity and self image to other important psychological factors.
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Bounded rationality and perfect rationality: psychology into economics

Bounded rationality and perfect rationality: psychology into economics

Simon’s work has been followed in the research on judgment and decision making, both in economics and psychology, so in his line of research psychology entered into economics. There are two major approaches which produced important insights into perception mechanisms shaping the individual’s internal representation of the problem. The first is the ‘‘heuristics and biases” program (Tversky, Kahneman, 1974), which has been fundamental to the contemporary development of behavioral economics. Behavioral economics generally begins with assumptions rooted in psychological regularity and asks what follows from those assumptions (Camerer, Loewenstein, 2003). Tversky and Kahneman offer a theoretical explanation about the observed deviations from perfect rationality, noting that people rely on “ heuristic principles which reduce the complex tasks of assessing probabilities and predicting values to simpler judgmental operations” (1974, p.1124). They therefore do not abandon the assumption that individuals are intelligent and intentional in making decisions, but they assume systematic and specific biases that move away the judgement from the perfect rationality of individuals. Moreover, according to Kahneman and Thaler (2006) to accept a model where individuals maximize their utility function, which, by hypothesis, is perceived to be consistent, accurate and also stable over time, is not possible anymore, because individuals often make systematic errors in predicting their future experience and results, thus failing to maximize their utility. This occurs because individuals in acting face real difficulty in assessing their preferences and, therefore, prefer the pursuit of instant gratification, which, however, are often inconsistent with their long-term preferences (Rabin, 1998). The "failures" of perfect rationality depend also on the specific ways in which people select and process the information mentally. The attitude to risk of the individual varies depending on frame within which lies the choice (Kahneman and Tversky, 1979). Kahneman and Tversky with their ‘Prospect theory’ (1979, 1984, 1986) have shown experimentally the presence of inconsistent judgments and choices by an individual facing the same problem presented in different frames (‘invariance of failures’). It follows that the frame, or the context of choice, ceteris paribus, helps to determine a different behavior. Among the violations of the expected utility paradigm, that have a psychological motivation and which are important in the financial choices, in particular there is the loss aversion, which implies the risk aversion (Kahneman and Tversky, 1984) 4 . Kahneman and Tversky have
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Social Capital of Urban Settlement

Social Capital of Urban Settlement

The social capital and urban settlement such as kampung are both significant issues in building the behavior and environment in architecture. The urban settlement is having the social capital, will help the community gain a better living. As mentioned above, that social community system includes social capital is one of essential part of urban settlement. This paper explores the social capital concept from many points of view such as economics, sociology, psychology, and settlements and the interface between urban settlement and the resident of kampung, particularly in relation to spatial aspect of social capital.
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Annual reportfor the year 1989

Annual reportfor the year 1989

Bowler, Department of Science and Technology August - "Psychology and economics" Dr Peter Earl, University of Tasmania September - Clive Lord Memorial Lecture: "Tasmania and the imperial[r]

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Book Review: The Pimping of Prostitution: Abolishing the Sex Work Myth by Julie Bindel

Book Review: The Pimping of Prostitution: Abolishing the Sex Work Myth by Julie Bindel

Part of the Civic and Community Engagement Commons, Civil Law Commons, Civil Rights and Discrimination Commons, Community-Based Learning Commons, Community-Based Research Commons, Community Psychology Commons, Criminal Law Commons, Criminology Commons, Domestic and Intimate Partner Violence Commons, Human Rights Law Commons, Law and Economics Commons, Law and Gender Commons, Law and Politics Commons, Law and Psychology Commons, Law and Society Commons, Legal Remedies Commons, Personality and Social Contexts Commons, Sexuality and the Law Commons, and the Social Work Commons
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Introduction: listen to "Money" singing

Introduction: listen to "Money" singing

In this special issue, then, critics approach Money by numerous routes: voice, style, ethics, literary tradition, comedy, masculinity, pornography, psychology, ideology, economics. Building on existing criticism of the novel – by such readers as James Diedrick, Jon Begley, Gavin Keulks and Emma Parker – they set new terms for future discussion of a work that will surely continue to appear central in its field. Hamilton’s intuition of Money’s enduring status has so far proved sound. The essays that follow demonstrate how the novel has retained its force and fascination.
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The Neuroscience of Consumer Decision Making

The Neuroscience of Consumer Decision Making

WHAT NEUROSCIENCE CAN REVEAL ABOUT CONSUMER DECISION-MAKING Decision-making is a fundamental part of human behavior. We all make decisions everyday that influence our health, well-being, finances, and future prospects among other things. Researchers have become increasingly interested in why we make the decisions we do, especially when in many cases these decisions do not appear rational or to benefit us in the long run. While neoclassical economics has traditionally looked at how people should behave, other disciplines, such as psychology and cognitive science, have tried to answer the question of why people act the way they do. A new discipline, referred to by some as neuroeconomics, has sought to meld theory and methodology from diverse areas such as economics, psychology,
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Who Knows?

Who Knows?

If the goals turn on empirical questions about modern society, then psychology, sociology, economics, and even political science departments seem likely to bring more to bear on the i[r]

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Brand Equity, Consumer Learning and Choice

Brand Equity, Consumer Learning and Choice

Figure 1 therefore includes many of the key constructs used in cognitive psychology views of brand equity. At the same time, the framework also incorporates the basic information economics constructs such as consumer uncertainty about preferences and tastes, and the associated perceived risk and information costs. Erdem and Swait (1998) suggest that a) brand investments and b) consistency of marketing actions over time and across marketing mix elements, increase the credibility of a brand as a signal of a product's position. This may increase perceived quality and decrease perceived risk and information costs. Similarly, consistency may also affect the clarity of the brand signal. Finally, constructs such as credibility may affect consumer utility weights, e.g. by reducing price sensitivity (Erdem, Swait and Louviere 1998). The brand investments and consistency constructs (Erdem and Swait 1998) also ®t into Figure 1 as exogenous variables that affect consumer perceptions (both mean and variance), as well as utility weights and information costs. As Morrison and Roberts (1998) show, consistency between the distribution elements of a ®nancial service and its features is more important than either mix element in isolation.
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Click here:

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Climate change is one of the most pressing yet intractable policy issues facing governments around the world. While its effects are already being seen, economic barriers – especially in light of current budget crises – have largely prevented most governments from seriously addressing it. Meanwhile the behavioral sciences – psychology, neuroscience, and behavioral economics – are producing mounting evidence for the effectiveness of a range of low-cost behavioral

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Application Area 2: Travel demand modelling: Travel behaviour research

Application Area 2: Travel demand modelling: Travel behaviour research

The main modeling tools used for the analysis modeling and prediction of travel choices stem from neoclassical economics in which individuals are assumed to make choices which are rational, consistent, perfectly informed and which maximize their economic utility by trading off between costs and benefits (5). However, research in behavioral sciences, especially cognitive psychology, indicates that individuals' choices in a wide range of contexts deviate from the predictions of the simpler forms of economic theory. Some of these deviations are systematic, consistent, robust and largely predictable. Evidence on systematic deviations from rational models have emerged from studies on financial behavior, consumer behavior, health behavior (e.g., (6,7,8,9,10)) and more recently –travel behavior (e.g. (11, 12,13,14)). This is somewhat in conflict with the traditional model of travel choice, in which travel is seen as a "derived
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Risk preference discrepancy : a prospect relativity account of the discrepancy between risk preferences in laboratory gambles and real world investments

Risk preference discrepancy : a prospect relativity account of the discrepancy between risk preferences in laboratory gambles and real world investments

A Prospect Relativity Account of the Discrepancy Between Risk Preferences in Laboratory Gambles and Real World Investments In psychology and experimental economics, experimental particip[r]

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The role of churches in tackling HIV stigma in eastern 
Zimbabwe

The role of churches in tackling HIV stigma in eastern Zimbabwe

Final Thesis 29 09 11 The role of churches in tackling HIV stigma in east ern Zimbabwe MERCY NETSAI NHAMO Submitted for the Doctorate Degree in Social Psychology London School of Economics and Politic[.]

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