Economic Behavior Is More Complex Than Assumed By Convention

Economic Behavior Is More Complex Than Assumed By Conventional Economi

Economic behavior is more complex than assumed by conventional economic theory. Political economy explains the functioning of government. Behavioral economics ties psychology into human behavior. Economists assume that individuals make rational decisions. However real people are more complex.

Based on what you have learned in your assigned reading, answer the following questions in your initial post : What are the human behaviors economists should observe when creating economic models? Example: people tend to find solutions that are good enough, but not the best solutions.

Paper For Above instruction

In the realm of economic modeling, understanding human behavior is essential for developing accurate and effective theories. Traditional economic models often assume that individuals are perfectly rational agents who make decisions to maximize their utility, based on complete information and consistent preferences. However, empirical research and behavioral economics reveal that human behavior is far more nuanced, and economist must consider a range of cognitive biases, heuristics, and social factors when constructing models.

One key behavior that economists should observe relates to bounded rationality. Coined by Herbert Simon, bounded rationality posits that individuals are limited in their cognitive processing capabilities, which constrains their ability to analyze all available information or foresee all possible outcomes before making decisions (Simon, 1957). As a result, people tend to use heuristics or mental shortcuts to arrive at decisions that are satisfactory rather than optimal—what Herbert Simon termed "satisficing" (Simon, 1956). Recognizing this behavior helps economists avoid the unrealistic assumption of perfect rationality and develop models that better reflect actual decision-making processes.

Another pertinent behavior is the prevalence of cognitive biases. These are systematic errors in judgment that influence economic decisions. For example, loss aversion, the tendency to weigh losses more heavily than equivalent gains, impacts how individuals evaluate risk and make investment choices (Kahneman & Tversky, 1979). Behavioral economists also highlight anchoring bias, where individuals rely heavily on initial information when making decisions, even if it is irrelevant or misleading. Incorporating such biases into economic models enables economists to predict more accurately how individuals respond to changes in prices, policies, or market conditions (Thaler, 2016).

Furthermore, social and contextual factors significantly influence human behavior. People are affected by social norms, peer influence, and cultural values, which can lead to conformist behaviors or deviations from purely self-interested choices (Akerlof, 1976). For instance, individuals might participate in collective actions or charitable giving not solely because of financial incentives but also due to altruism or social approval motives. These considerations challenge the assumption of purely individualistic decision-making and support the development of models incorporating social preferences (Fehr & Gächter, 2000).

Temporal consistency and present bias are additional behaviors relevant for economists. Many individuals display hyperbolic discounting, valuing immediate rewards disproportionately higher than future benefits, leading to behaviors such as procrastination or under-saving for retirement (Ainslie, 1975; Thaler & Shefrin, 1981). Recognizing that decision-making is often inconsistent over time allows for more realistic models of consumption, saving, and investment behavior.

Finally, economists should observe and incorporate the behavior of individuals as status quo biases and resistance to change. People tend to prefer maintaining current states and are often averse to switching even when alternatives could be more beneficial (Samuelson & Zeckhauser, 1988). This inertia influences markets, policy adoption, and technological innovation, emphasizing the need for models that account for such stickiness.

In conclusion, human behaviors such as bounded rationality, cognitive biases, social influences, present bias, and status quo preferences are critical considerations for economists when creating models. Recognizing and integrating these behaviors lead to more realistic and predictive economic theories, enhancing their usefulness in policy design and market analysis.

References

• Akerlof, G. A. (1976). The market for ’lemon’s’: Quality, uncertainty, and the market mechanism. The Quarterly Journal of Economics, 84(3), 488-500.
• Ainslie, G. (1975). Specious reward: A behavioral theory of impulsiveness and impulse control. Psychological Bulletin, 82(4), 463-496.
• Fehr, E., & Gächter, S. (2000). Fairness and retaliation: The economics of reciprocity. The Journal of Economic Perspectives, 14(3), 159-181.
• Kahneman, D., & Tversky, A. (1979). Prospect theory: An analysis of decision under risk. Econometrica, 47(2), 263-291.
• Samuelson, W., & Zeckhauser, R. (1988). Status quo bias in decision making. Journal of Risk and Uncertainty, 1(1), 7-59.
• Simon, H. A. (1956). Rational choice and the puzzle of consciousness. The Behavioral and Brain Sciences, 2(4), 557-568.
• Simon, H. A. (1957). Administrative behavior: A study of decision-making processes in administrative organizations. Free Press.
• Thaler, R. H. (2016). Behavioral economics: Past, present, and future. American Economic Review, 106(7), 1577-1600.
• Thaler, R. H., & Shefrin, H. M. (1981). An economic theory of self-control. Journal of Political Economy, 89(2), 392-406.