Behavioral Economics: Past, Present, and Future

There has been growing interest in the field come to me known as “behavioral economics” which attempts to incorporate insights from other social sciences, especially psychology, in order to enrich the standard economic model. This interest the underlying psychology of human behavior returns economics to its earliest roots. Scholars such as Adam Smith talked about such key concepts as loss aversion, overconfidence, and self-control. Nevertheless, the modern version of behavioral economics introduced in the 1980s met with resistance by some economists, who preferred to retain the standard neo-classical model. They introduced several arguments for why psychology could safely be ignored. In this essay I show that these arguments have been rejected, both theoretically and empirically, so it is time to move on. The new approach to economics should include two different kinds of theories: normative models that characterize the optimal solution to specific problems and descriptive models that capture how humans actually behave. The latter theories will incorporate some variables I call supposedly irrelevant factors. By adding these factors such as framing or temptation we can improve the explanatory power of economic models. If everyone includes all the factors that do determine economic behavior, then the field of behavioral economics will no longer need to exist.