Redefining economic theories?

Critics of behavioural economics typically stress the rationality of economic agents

Richard H. Thaler, whose work has persuaded many economists to pay more attention to human behavior, and many governments to pay more attention to economics, was awarded the Nobel Memorial Prize in Economic Sciences for the year 2017. Professor Thaler is the rare economist to win a measure of fame before winning the prize. He is an author of a best-selling book, “Nudge,” about helping people to make better decisions. He also appeared in the 2015 film “The Big Short,” delivering what is surely one of the most widely viewed tutorials in the history of economics, on the causes of the 2008 financial crisis. Asked how he would spend the prize money of about $1.1 million, Professor Thaler replied, “This is quite a funny question.” He added, “I will try to spend it as irrationally as possible.” Thaler, 72 and a professor at the University of Chicago, is one of the founders of behavioral economics and finance, a field which once drew derision from some academics before entering the mainstream over the past decade. He was made a Nobel laureate for shedding light on how human weaknesses such as a lack of rationality and self-control can ultimately affect markets. The co-author of the 2008 best-seller “Nudge” has “built a bridge between the economic and psychological analyses of individual decision-making,” the Royal Swedish Academy of Sciences said in a statement. A rational behavior decision-making process is based on making choices that result in the most optimal level of benefit or utility for the individual. Most conventional economic  theories are created and used under the assumption all individuals taking part in an action/activity are behaving rationally. A rational behavior decision-making process is based on making choices that result in the most optimal level of benefit or utility for the individual. Most conventional economic theories are created and used under the assumption all individuals taking part in an action/activity are behaving rationally. In any economic theory, the word Ceterus Parebus, which is all things remaining as unchanged including the behaviour of the consumer remains the same. Rational behavior does not necessarily always involve receiving the most monetary or material benefit because the satisfaction received could be purely emotional.

For a choice to be deemed rational, it must often remove any and all emotional components from the decision-making process and focus solely on the facts as they are presented. Even with emotion removed, more than one determination for a situation may be deemed rational as long as it can be logically explained. One such decision could involve whether to place funds in one bond or another if they both hold similar rates of return and have similar maturity dates. The value maximisation premise of neo classical rational choice theory assumes that, when confronted with various alternative courses of action, the self interested human will choose that maximises his or her individual utility.

In his 2015 book, a memoir-cum-manifesto, Thaler clearly states the crux of his career-long argument: economics needs to take human behavior into account. People are biased when making decisions, and that human miscalculation can come with serious consequences. Both economic forecasters and policy-setting governments need to take the fact that actors are human into account, he argues. "The primary reason for adding Humans to economic theories is to improve the accuracy of the predictions made with those theories,” he writes, quipping that behavioral economics comes with the added benefit of being more interesting and more fun. “It is the un-dismal science.”Thaler co-wrote the 2008 global bestseller Nudge with former White House adviser Cass Sunstein, a law professor at Harvard University and a Bloomberg View columnist. In it, the authors examine why people make the choices they do, looking at biases and the limits of human reason. In it, they make the case that while humans often make choices that don’t result in their longer-term well-being -- for example, eating unhealthy foods that lead to obesity -- society can drive better decisions via "choice architecture," or by better organizing the context in which people make decisions. To illustrate, they use the example of an actual architect. "As good architects know, seemingly arbitrary decisions, such as where to locate the bathrooms, will have subtle influences on how the people who use the building interact," they write in their introduction. “A good building is not merely attractive; it also ‘works.”’Thaler and his co-authors show that TV game show contestants make so-called path-dependent choices writes, what happened earlier in the show influences how they behave as the program progresses. In the game show, various sums of money have been allocated to 26 briefcases, and as the show progresses -- as briefcases are opened, revealing the sums within -- she has the option to take a deal to walk away or continue to play, risking losing out in exchange for the chance at a bigger reward. They find that risk tolerance in later rounds varies widely among contestants, but it’s limited among those who do badly (eliminating high-value briefcases) or those who get lucky (opening low-value briefcases) early on in the game. “The relatively low risk aversion of losers and winners is hard to explain with expected utility theory and points in the direction of reference-dependent choice theories,” the authors write.

In the 2015 movie The Big Short, Thaler made a cameo with pop star and actress Selena Gomez. The movie won the 2016 Academy Award for the Best Adapted Screenplay. The film was based on Michael Lewis’s book The Big Short: Inside the Doomsday Machine and it follows real characters’ lives before and during the 2008 financial crisis. In the cameo, Thaler explains the psychological fallacy of a hot hand to help reveal how a key part of the financial crisis came about. In the scene, Gomez explains the concept of the "hot hand fallacy," a key behavioral feature that drove the rise of synthetic collateralised debt obligations - one of the key drivers of the US subprime mortgage crisis in 2007. "The Big Short" movie is based on Michael Lewis' book "The Big Short: Inside the Doomsday Machine" on the 2007-2008 financial crisis.

Critics of behavioural economics typically stress the rationality of economic agents. They contend that experimentally observed behaviour has limited application to market situations, as learning opportunities and competition ensure at least a close approximation of rational behaviour. There is school of thought that many of the well-established and tried and tested policies which behavioural economics has challenged (by suggesting that small nudges are better than large scale interventionist measures) provide more effective types of behaviour change.

For example, some argue that higher fuel taxes yield a better result than small nudges towards better environmental decisions.  Other critics argue that much of the impact of nudge-type policy is short term, and does not lead to long lasting changes in behaviour. A notable concern is that despite a great deal of rhetoric, there is no real consistent behavioral theory yet. Behavioral economics scholars also have no unified theory. Until that happens, it is a collection of loosely related or unrelated observations. What is missing is a foundational behavioral theory that can be tested in many domains as a competitor to neoclassical theory. Traditional economists are also skeptical of the experimental and survey-based techniques which behavioral economics uses extensively. Economists typically stress revealed preferences over stated preferences (from surveys) in the determination of economic value. Experiments and surveys are at risk of systematic biases, strategic behavior and lack of incentive compatibility. 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. For example, behavioral economists are investigating neuro economics, which is entirely experimental and cannot yet be verified in the field.  Other proponents of behavioural economics note that neoclassical models often fail to predict outcomes in real world contexts. Behavioural insights can influence neoclassical models. Behavioural economists note that these revised models not only reach the same correct predictions as the traditional models, but also correctly predict some outcomes where the traditional models failed. This will indeed be quite interesting to see how the future unfolds  in front about the debate with the Behavioural Economic model with the Nobel Prize to Richard H. Thaler this year.

The writer, a banker by profession, has worked both in local and overseas market with various foreign and local banks in different positions

Redefining economic theories?

Critics of behavioural economics typically stress the rationality of economic agents

Richard H. Thaler, whose work has persuaded many economists to pay more attention to human behavior, and many governments to pay more attention to economics, was awarded the Nobel Memorial Prize in Economic Sciences for the year 2017. Professor Thaler is the rare economist to win a measure of fame before winning the prize. He is an author of a best-selling book, Nudge, about helping people to make better decisions. He also appeared in the 2015 film The Big Short, delivering what is surely one of the most widely viewed tutorials in the history of economics, on the causes of the 2008 financial crisis. Asked how he would spend the prize money of about $1.1 million, Professor Thaler replied, This is quite a funny question. He added, I will try to spend it as irrationally as possible. Thaler, 72 and a professor at the University of Chicago, is one of the founders of behavioral economics and finance, a field which once drew derision from some academics before entering the mainstream over the past decade. He was made a Nobel laureate for shedding light on how human weaknesses such as a lack of rationality and self-control can ultimately affect markets. The co-author of the 2008 best-seller Nudge has built a bridge between the economic and psychological analyses of individual decision-making, the Royal Swedish Academy of Sciences said in a statement. A rational behavior decision-making process is based on making choices that result in the most optimal level of benefit or utility for the individual. Most conventional economic theories are created and used under the assumption all individuals taking part in an action/activity are behaving rationally. A rational behavior decision-making process is based on making choices that result in the most optimal level of benefit or utility for the individual. Most conventional economic theories are created and used under the assumption all individuals taking part in an action/activity are behaving rationally. In any economic theory, the word Ceterus Parebus, which is all things remaining as unchanged including the behaviour of the consumer remains the same. Rational behavior does not necessarily always involve receiving the most monetary or material benefit because the satisfaction received could be purely emotional. For a choice to be deemed rational, it must often remove any and all emotional components from the decision-making process and focus solely on the facts as they are presented. Even with emotion removed, more than one determination for a situation may be deemed rational as long as it can be logically explained. One such decision could involve whether to place funds in one bond or another if they both hold similar rates of return and have similar maturity dates. The value maximisation premise of neo classical rational choice theory assumes that, when confronted with various alternative courses of action, the self interested human will choose that maximises his or her individual utility. In his 2015 book, a memoir-cum-manifesto, Thaler clearly states the crux of his career-long argument: economics needs to take human behavior into account. People are biased when making decisions, and that human miscalculation can come with serious consequences. Both economic forecasters and policy-setting governments need to take the fact that actors are human into account, he argues. The primary reason for adding Humans to economic theories is to improve the accuracy of the predictions made with those theories, he writes, quipping that behavioral economics comes with the added benefit of being more interesting and more fun. It is the un-dismal science.Thaler co-wrote the 2008 global bestseller Nudge with former White House adviser Cass Sunstein, a law professor at Harvard University and a Bloomberg View columnist. In it, the authors examine why people make the choices they do, looking at biases and the limits of human reason. In it, they make the case that while humans often make choices that dont result in their longer-term well-being -- for example, eating unhealthy foods that lead to obesity -- society can drive better decisions via choice architecture, or by better organizing the context in which people make decisions. To illustrate, they use the example of an actual architect. As good architects know, seemingly arbitrary decisions, such as where to locate the bathrooms, will have subtle influences on how the people who use the building interact, they write in their introduction. A good building is not merely attractive; it also works.Thaler and his co-authors show that TV game show contestants make so-called path-dependent choices writes, what happened earlier in the show influences how they behave as the program progresses. In the game show, various sums of money have been allocated to 26 briefcases, and as the show progresses -- as briefcases are opened, revealing the sums within -- she has the option to take a deal to walk away or continue to play, risking losing out in exchange for the chance at a bigger reward. They find that risk tolerance in later rounds varies widely among contestants, but its limited among those who do badly (eliminating high-value briefcases) or those who get lucky (opening low-value briefcases) early on in the game. The relatively low risk aversion of losers and winners is hard to explain with expected utility theory and points in the direction of reference-dependent choice theories, the authors write. In the 2015 movie The Big Short, Thaler made a cameo with pop star and actress Selena Gomez. The movie won the 2016 Academy Award for the Best Adapted Screenplay. The film was based on Michael Lewiss book The Big Short: Inside the Doomsday Machine and it follows real characters lives before and during the 2008 financial crisis. In the cameo, Thaler explains the psychological fallacy of a hot hand to help reveal how a key part of the financial crisis came about. In the scene, Gomez explains the concept of the hot hand fallacy, a key behavioral feature that drove the rise of synthetic collateralised debt obligations - one of the key drivers of the US subprime mortgage crisis in 2007. The Big Short movie is based on Michael Lewis book The Big Short: Inside the Doomsday Machine on the 2007-2008 financial crisis. Critics of behavioural economics typically stress the rationality of economic agents. They contend that experimentally observed behaviour has limited application to market situations, as learning opportunities and competition ensure at least a close approximation of rational behaviour. There is school of thought that many of the well-established and tried and tested policies which behavioural economics has challenged (by suggesting that small nudges are better than large scale interventionist measures) provide more effective types of behaviour change. For example, some argue that higher fuel taxes yield a better result than small nudges towards better environmental decisions. Other critics argue that much of the impact of nudge-type policy is short term, and does not lead to long lasting changes in behaviour. A notable concern is that despite a great deal of rhetoric, there is no real consistent behavioral theory yet. Behavioral economics scholars also have no unified theory. Until that happens, it is a collection of loosely related or unrelated observations. What is missing is a foundational behavioral theory that can be tested in many domains as a competitor to neoclassical theory. Traditional economists are also skeptical of the experimental and survey-based techniques which behavioral economics uses extensively. Economists typically stress revealed preferences over stated preferences (from surveys) in the determination of economic value. Experiments and surveys are at risk of systematic biases, strategic behavior and lack of incentive compatibility. 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. For example, behavioral economists are investigating neuro economics, which is entirely experimental and cannot yet be verified in the field. Other proponents of behavioural economics note that neoclassical models often fail to predict outcomes in real world contexts. Behavioural insights can influence neoclassical models. Behavioural economists note that these revised models not only reach the same correct predictions as the traditional models, but also correctly predict some outcomes where the traditional models failed. This will indeed be quite interesting to see how the future unfolds in front about the debate with the Behavioural Economic model with the Nobel Prize to Richard H. Thaler this year. The writer, a banker by profession, has worked both in local and overseas market with various foreign and local banks in different positions