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Topic 0

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sonja.ilmes
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ECNM10066

Topic 0: What is Behavioural


Economics?
Lecturer: Darija Barak

Indebted to Vincent Crawford whose various lecture notes were used for the creation of slides
decks for this course.
17/01/2024 1
Neoclassical economics

John Stuart Mill (1806-73) proposed “an arbitrary definition of man, as a being who
inevitably does that by which he may obtain the greatest amount of necessaries,
conveniences, and luxuries, with the smallest quantity of labour and physical self-denial
with which they can be obtained”.

Famous thinkers of the 19th century – from John Stuart Mill and Adam Smith, to Francis
Edgeworth, William Stanley Jevons, Léon Walras, and Vilfredo Pareto – embraced the
idea which became known as homo economicus (as opposed to homo sapiens).

17/01/2024 2
Neoclassical economics
Homo economicus
• Is perfectly rational, making choices that consistently maximise some exogenous,
stable set of preferences that depend on absolute levels of outcomes, even with
uncertainty, and even in dynamic situations.
• Is also perfectly rational in the sense of costlessly and correctly making
nonprobabilistic logical inferences and probabilistic judgments (via Bayes’ Rule,
contingent reasoning, option value).
• Is perfectly self-interested, caring exclusively about their own consumption (though
this assumption is not essential to mainstream theory).
• Has perfect will-power and the ability to make and follow (complex) intertemporal
plans with no conflict between the preferences of current and future selves.

17/01/2024 3
Neoclassical economics
In many scenarios, reasonable stylisations of the fact that people are mostly self-
interested and well-informed, with coherent goals and reasonable skill at making plans.

Moreover, these assumptions give great tractability to our analytical models.

Yet, oftentimes they struggle to meaningfully capture actual human behaviour with
wide-ranging and important consequences.

As a consequence, important research topics including preferences, beliefs, information


processing etc have been ignored by economists for a long time, hindering research
progress.
17/01/2024 4
Behavioural economics
• Effectively blends of neoclassical economics with better motivated assumptions about
human behaviour derived from empirical observation and psychology.
• Can be subdivided into behavioural decision theory and behavioural game theory.
• In its’ early days, behavioural economics focused on identifying anomalies – ie
patterns in behaviour that are at odds with neoclassical economics – and formulating
alternative conceptualisations.
• Behavioural economists then moved to formalising these alternatives using
mathematical modelling and working on empirical testing.
• These days, research looks onto ways of embedding new and old assumptions into
general, more flexible models, formulating new theories and seeking further empirical
validation.

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Behavioural economics
Basic premises of modern behavioural economics:
• Adding behavioural assumptions does not imply abandoning neoclassical
assumptions, which are often reasonable and appropriate even if not
always exactly right.
• Adding behavioural assumptions does not imply abandoning traditional
methods. To this end, standard mathematical methods should continue to
be employed, testing should be done using standard statistics, evaluation
of the models should be done using standard scientific criteria such as
parsimony, prediction, generality, insight.
• Behavioural economics should enhance neoclassical economics, not
replace it. To this end, the two should ultimately merge.
17/01/2024 6
Where to next?
• Topic 1: Decisions under risk and uncertainty

17/01/2024 7

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