2 - why hasnt economics been experimental and behavioural all along? Flashcards
(18 cards)
what is behavioural economics
making economics more psychologically realistic
what was economics in 20th century
orthodox economics
what were the 3 key features of 20th century economics
- purge economic theory of unobservable concepts = unscientific
- found economic theory on a formal model of rational agents
- choices are observable, but psychological experiences (happiness) is not
what was orthodox economics thoughts on realism?
what didnt it seek…
- didnt seek psychological realism
- realistic underlying assumptions
didnt include psychology
how did the 19th century involve psychology into economics
used concept of utility
* utility was psychological experience (happiness, pleasure)
* definition of utility = happiness
* using science of pleasure - how they measure happiness
- diminishing marginal utility?
why did science of pleasure end
early 20th century
- doubts possibility of measuring happiness or comparing across people
- unobservable psychological experience
what did the definition of utility change to in 20th century
utility = a representation of complete and consistent preferences
utility = preferences of outcomes
what are complete preferences
an individual can always compare 2 outcomes
- they prefer one over the other
- or they are indifferent
- there isnt a case where they cant compare 2 options
what are transitive preferences
reflects consistency in decision making
- if a preferred over b, and b preferred over c - then a must be preferred over c
what does a utility function show
what does maximisation of utility function represents
utility function represents rational preferences = representation of preferences
maximisation represents satisfaction of the preferences - provided they are complete and transitive
what does maximising utility mean
agent chooses actions that best satisfy their preferences over outcomes
- concept of rationality - not realism
what is the pareto criterion - how are preferences used in welfare economics
pareto - improvements without harming anyone
* welfare economics
what was Militon Friedmans view on realistic assumptions
- methods do not need realistic assumtpions
- as long as they predict successfully what they intended to predict
- theory is judged by its predictive power
how does BE build on standard economics
- explanation is important, not just predictive power
- greater psychological realism
- extends existing models - by adding more psychological realism
what is example 1 of how BE can be used to extend standard theory
Ernst Fehr and Schmidt
- utility function that combines 3 motivations
- material self interest, envy, guilt
- orthodox model - people are only interested in their self - not others
what is example 2 of how BE can be used to extend standard theory
preferences maximisation
- allow for over weighting/under weighting of particular probabilities
what is example 3 of how BE can be used to extend standard theory
discounted utility with exponential discountings
- BE model = quasi-hyperbolic discounting model
- adds in Beta, that reduces the weight on all future periods by a constant factor - but not the present
why is quasi hyperbolic discounting model a better model than standard exponential discounting
- people exhibit time inconsistency
- exponential discounting assumes that individuals discount future rewards at a constant rate,
- quasi-hyperbolic discounting recognizes the tendency for individuals to exhibit time inconsistency in their decision-making
- higher weight placed on present - immediate
- creates potential for procrastination, self control problems
- by this small change by adding Beta - can introduce more complex and realistic psychology
