Monday, September 13, 2010

Introduction to Behavioural Economics Lecture 1

Behavioural Economics and Public Policy, a third year undergraduate option for Economics students, began today. I will post a little about aspects of it throughout this term and I am interested in corresponding with other people running courses like this or discussing aspects of the material with people.

The introductory lecture introduced myself and the course materials. In terms of substantive content, the lecture gave a definition and brief overview of Behavioural Economics. Ancient and Medieval Philosophy in general did not make distinctions between the disciplines of Economics and Psychology. Economics as a distinct discipline has many roots, with origins around the late 1700s with works such as Adam Smith's "An Inquiry into the Nature and Causes of the Wealth of Nations" being one clear point of departure. Psychology made its clear departure from philosophy in the late 1800s. At this time, there was a great deal of work at the intersection of the emerging fields of economics and psychology, with a substantial amount of time devoted to integrating psychophysics into utility theory. For the most part, this project did not influence the mainstream economics that dominated the 20th century. Economics developed along the lines of an axiomatic science like physics whereas psychology progressed along an empirical route heavily influenced by experimental design and biology. While the integration of Economics and Psychology attains its most recognisable expression in the work of Herbert Simon and of Kahneman, Tversky and colleagues; it should be pointed out that several streams of research existed throughout the 20th century that sought to bring psychological realism to Economic models including the work associated with George Katona which yielded, inter alia, the consumer sentiment analyses that we are mostly all familiar with. Following the pioneering judgement studies of Kahneman and Tversky and their development of prospect theory, research into behavioural economics flourished in the late 20th century. Kahneman cites Richard Thaler in his Nobel address as being chiefly responsible for the integreation into economics, with Thaler's work being responsible for an increasing awareness of the limitation of rationality assumptions in Economics. Increasingly, behavioural economics has moved from examining anomolies in the standard accounts of decision making toward developing first-principles models based on arguably more realistic assumptions. Modern leaders in the field include Ernst Fehr, David Laibson and Matthew Rabin who's work will appear in the course in various ways.

This course begins with an account of rationality in economics, which is largely defined as adherence to a set of consistency axioms in conditions of certainty and uncertainty. The course then examines early doubts about the empirical validity of these models, including anamolies such as the Allais and Ellsberg paradoxes, and empirical evidence on loss aversion and the endowment effect. The course then examines how people make judgments of risk and uncertainty, in particular examining the classic heuristics work of Kahneman and colleagues. We then examine how people make intertemporal decisions, in particular examining the standard exponential discounting model and comparing it to models with hyperbolic discounting. Subsequent lectures examine a number of key planks of behavioural economics - the effect of emotions on decision making; how identity affects decisions and valuations; and how people are influenced by groups. All of this leads to a discussion of value and welfare. To what extent does behavioural economics pose a challenge for traditional measures of welfare such as consumption? The final third of the course will examine the wider policy relevance of Economics drawing from case studies in areas such as climate change, financial regulation, internet privacy, pension policy and so on from around the world. We will examine in detail the idea of "Libertarian Paternalism" outlined by Thaler and Sunnstein, the idea that state governments and other agencies have a potentially positive role in shaping behaviour while respecting freedom of choice.

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