18.2 Does Behavioral Economics Mean Everything We’ve Learned Is Useless?

At this point, you may be wondering why you bothered reading 17 chapters on economic models only to find out that behavioral economics says people don’t actually behave the way the models predict they would. And, it may seem that we could have simply avoided studying difficult models and theories that don’t work and instead just read a book on behavioral economics.

Although these qualms seem reasonable, they are not correct. First of all, the behavioral anomalies we’ve discussed in this chapter do not invalidate the economic models you’ve learned. They show us that some people, under certain circumstances, act in a way that the basic models might miss. But, the foundational models you have learned actually do a remarkably good job of describing how the economic world works most of the time. When describing something as complex as human behavior, that is still an important advance. Moreover, the ongoing research in behavioral economics might suggest ways in which these models could be augmented in some cases to better describe behavior, without moving too far away from the traditional notions of homo economicus.

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13Gary S. Becker and Kevin M. Murphy, “A Theory of Rational Addiction,” Journal of Political Economy 96, no. 4 (August 1988): 675 – 700.

Second, in many areas in which behavioral economics seems to give a different answer, simple adjustments to the basic economic model often provide perfectly viable alternative explanations. As an example, think about behaviors that the basic, rational consumer decision-making model might have a hard time explaining, such as people becoming addicted to things that are bad for them, like smoking cigarettes. Yet, Nobel laureate Gary Becker has developed conventional economic models to explain such seemingly irrational behaviors. His “rational addiction” model (developed with Kevin Murphy) is just a variant of the consumer behavior theory we studied in 13 In it, consumers think about the lifetime costs of becoming addicted and balance that against the utility they get from smoking, knowing that starting now will make it hard to stop in the future. This theory can explain why addiction rates respond to prices, for example, in a better way than an explanation based on the belief that people become addicted because they just can’t help themselves.

Third, as we emphasized in the previous section, people and firms that have systematic biases can lose out to people in the marketplace who are not biased. Markets can weed out systematic biases, and economic actors that participate repeatedly in markets often recognize and adjust for their behavioral biases or just exit the marketplace completely. Once biased participants are gone, remaining participants exhibit less irrationality than might a random survey respondent.

It is important for economists and businesses to test how people behave as thoroughly as they can. This desire to better understand the behavior of consumers, customers, suppliers, and producers has led to the rise of another new field of economics: experimental economics.