New book: 'Economics and Psychology'

A belated post to acknowledge a welcome new volume, Economics and Psychology: Developments and Issues, published in July by MIT Press. Edited by the University of Zurich's Bruno S. Frey and University of Basel's Alois Stutzer, it appears to have a first rate selection of contributions. You can read the table of contents and download chapter one here.

The editors acknowledge in their introductory chapter the debt that economcs owes to psychology:

...together economics and psychology is a vibrant and fruitful field. We have argued that psychology has had a strong impact on economics: it has helped to substitute the assumption of complete rationality by isolating anomalies in individual behavior; it has made experiments a valid and widely accepted method of research; it has broadened the view of human nature by showing pro-social, intrinsic, and procedural aspects in people’s preferences; and by showing that utility can be measured it has produced important knowledge about what people care for.

The danger that economics and psychology becomes an additional playground for exhibiting one’s mathematical prowess is perhaps smaller than in other areas because psychologists’ influence has from the very beginning introduced a strong empirical (experimental) orientation. We have argued that remarkable insights have already been reached but at the same time we are fully aware that in so many respects we still know so little. The field is wide open for future research.

As my copy is in the post, I provide excerpts from a review of the book by the University of Massachusetts's Herb Gintis, which he posted on Amazon.com:

...the book under review is only in passing about the Kahneman-Tversky influence on decision theory. Rather, it focuses on a second wave of behavioral experiments involving strategic interaction (game theory) rather than single-agent choice (decision theory). Economists have been at the center of this new "behavioral game theory," which began with the famous ultimatum game experiment of Werner Gueth in 1982 (Guth, 1982). Indeed, except for Ralph Herwig, almost every contributor to this volume is trained in economics or business rather than psychology.

...Behavioral game theory has produced some quite notable results. Most important, researchers are corroborating what sociologists and social psychologists have known for a long time: human beings are not the self-regarding, asocial, materialistic creatures assumed in traditional economic theory under the rubric of homo economicus. Rather most laboratory and field subjects care about fairness and justice, and are willing to sacrifice material gain in the pursuit of normative goals. Moreover, most individuals have a more or less firm commitment to such character virtues as honesty, dependability, and trustworthiness, and are willing to forego some level of personal material reward in order to conform to the principles of virtuous conduct. More generally, people care about process as well as outcome in their interactions, so are more likely to contribute to a project that was democratically chosen rather than autocratically imposed, and their notions of fairness include such other-regarding elements as returning good for good and evil for evil.

The various contributors to this volume are almost all highly visible and creative leaders in their fields. The chapters are uniformly informative and well written. Several are illuminating in both reviewing the literature and providing an analysis of a single issue in journal article depth. Topics covered include prosocial behavior and trust in general, conditional cooperation and punishment, gender differences in trusting behavior, the neuroeconomics of decision-making, measuring subjective satisfaction and finding its causes, problems of self-control and time inconsistency, procedural utility, and recommendations for closer collaboration of psychologists and economists.

Comments

[Lafayette]

From Chapter 1: "... our general impression is that so far
rather few economic elements have been brought into psychology."

They can say that again.

It is curious that, in a science that bases a great deal of its fundamental principals upon consumer demand, and relates to that factor employing the word "propensity", then it is surely opening itself to a psychological dimension.

Consider present history, i.e., the speculative sub-prime frenzy. Was that not psychological in nature? Even though elliptical comments posted regarding the subject tried to analyze the phenomenon in a purely scientific way.

Any marketeer knows that they must "seduce" the consumer to buy their product and neither assuring its availability (supply) nor prompting consumer interest (demand) determines -- really and truly -- price. (In fact, the Supply/Demand model is a purely academic explanation of a far more complex interactive function between the two variables.)

Even in business, we like to think that investments respond to a well articulated R-O-I analysis -- when in fact most FDI depends upon a herd-instinct to do what others have done, because it seems less risky if others are already doing it. (This behaviour has been observed in mice as well.)

So, I would not remain with psychology alone as an influence on economics but add sociology as well. Maybe we have the birth, thereby, of a new science? Called Socio-psychological Economics?

[Lafayette]

Also from Chapter 1: "If an individual buys, sells, or produces more of a good, an individual j might either have an incentive to decrease her demand or supply (i.e., strategic substitutability prevails between actions) or to increase it (i.e., there is strategic complementarity between actions). With strategic substitutability, a minority of rational agents can be sufficient to produce a rational outcome ,while with complementarity a small fraction of irrational agents can lead to strong deviations from market fundamentals, as observed with the stock market bubble in the late1990s."

Economists should be taught (1) plain English, (2) never repeat words that have synonyms – it’s lazy writing and (3) use concrete examples to explain abstract notions.

Apparently “complementarity” is important to the authors, they repeat it twice, just like “substitutability”. But, they never explain what the words mean by simple examples that the uninitiated, like me, can understand in a given context.

We are supposed to comprehend from the context because …. like them, "we speaka da lingo”. Bollocks.

Anyway, if all the above somehow explains the psychological stock market frenzy referred to in the very last sentence … I’m a monkey’s uncle. (He wrote, scratching his armpit. ;^)

[Martijn Boermans]

You have a good point that economists implicitly keep their analysis abstract thereby making a strong assumption about the context. Every analysis in current economics assumes equilibria, rational actors and optimizing behavior.

The incorporation of uncertainty and imperfect information has led to a
fundamental paradigm shift in economics (e.g. Stiglitz, 2002; Kuhn, 1970). Traditional economics
holds that supply and demand forces gravitate the economy towards a general equilibrium. Total
welfare of society is determined and derived from decisions and actions of individual agents. On
the basis of information individuals choose and behave in order to obtain maximum utility.
Understanding how decision-making agents think about problems is a new area of economics

Yet, this idea of optimal cognition suffers from an infinite regress problem: if cognition is costly, then optimizing cognition is also costly, leading one to optimize the optimization, and so on ad infinitum (Conlisk, 1996; Lipman, 1991). Decision-making requires cognitive operations, including information acquisition and information processing, which often happen under suboptimal (non-rational) conditions. The analysis of cognitive processes creates elementary doubts to the traditional assumption of rationality. Agents are assumed to act bounded rational.

I myself am a graduate student in Multidisciplinairy Economics and I pray the authors of this book for laying a new foundation within the economic discipline and beyond. Aside from the formalistic presentation, I agree with a analytical science which incorporates both psychology and economics, Rigor analysis is fruitful and people who need examples from everyday life might not understand the beautiful world of hyperspace.

For example, many psychologists know about the phenomena of the "self serving bias". Ask an economist what this means and you have low chance of finding any experts. However, a short mathematica presentation of this interesting phenomena (formalistic language, sorry for the repetition, but by definition a necessity) and "the economist will understand it most deeply". [see eg. Kaplan and Ruffle, "The Self-serving Bias and Beliefs about Rationality", in Economic Inquiry, 2004, vol. 42, issue 2, pages 237-246.]

A free exhange of ideas between psychologists and economists can only continue if psychologist dare to encapulate mathematical language. Economists must understand that humans are not automatic rational calculating machines, but embrace insights from psychology into the beauty of human 'automatic' irrationalities (I wrote a thesis on Fear Appeals)

[Martijn Boermans]

[edit: I have made two quotes from my working paper "The Microeconomics of Information Acquisition"]

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