Thaler, R.Behavioral economics: Past, present, and future

Recommended reading

Richard H. Thaler

Release date:
July 2016

American Economic Review, Volume 106, Number 7, pages 1577-1600

In recent years there has been growing interest in the mixture of psychology and economics that has come to be known as "behavioral economics". As is true with many seemingly overnight success stories, this one has been brewing for quite a while. Thaler's paper on the subject was published in 1980, hot on the heels of Kahneman and Tversky’s (1979) blockbuster on prospect theory, and there were earlier forerunners, most notably Simon (1955, 1957) and Katona (1951, 1953). The rise of behavioral economics is sometimes characterized as a kind of paradigm-shifting revolution within economics, but I think that is a misreading of the history of economic thought. It would be more accurate to say that the methodology of behavioral economics returns economic thinking to the way it began, with Adam Smith, and continued through the time of Irving Fisher and John Maynard Keynes in the 1930s.

In spite of this early tradition within the field, the behavioral approach to economics met with considerable resistance within the profession until relatively recently. In this essay Thaler begins by documenting some of the historical precedents for utilizing a psychologically realistic depiction of the representative agent. The author then turns to a discussion of the many arguments that have been put forward in favor of retaining the idealized model of Homo economicus even in the face of apparently contradictory evidence. Thaler argues that such arguments have been refuted, both theoretically and empirically, including in the realm where we might expect rationality to abound: the financial markets. As such, it is time to move on to a more constructive approach.

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