How Behavioral Economics Differs From Classical Economics
Economics has long been thought to be the most scientific of the social sciences. Economists analyze data and use complex mathematical models to examine human behavior. In doing so, they make several assumptions about people and their habits, mainly that we have unbounded rationality, unbounded willpower, and complete selfishness. Almost all economic theories are based on these principles. Behavioral economists point out that real people don’t behave this way. People act irrationally, without self control, and against their own-self interest. This disconnect between models and reality makes modifications to these theories necessary when applied in real life, as you will see below.
The most basic assumption is unlimited rationality. Economists expect people to be perfectly logical when making decisions. Unfortunately, people are not always so smart. One study conducted on taxi drivers found that instead of driving more on good days and less on bad days, cabbies set a price target for each day and stop once they hit that target, a strategy which is not mathematically profit-maximizing. The “bounded” mistake-making rationality that real people have can often cost them money. Behavioral economists suggest changes to prevent people from making these errors, like asking taxi unions to inform cabbies of the best money-making strategies. Another change that a behavioral economist would endorse is asking companies to automatically enroll employees in a 401k plan with recurring deposits so employees don’t make the wrong decision and not save enough money for retirement.
Unbounded willpower is the most clearly incorrect assumption economists make. Anyone reading this can think of a time where despite knowing the best thing to do, they did something else. Millions of people smoke cigarettes, eat unhealthy foods, and procrastinate when faced with important tasks. This lack of control has created products and people dedicated to overcoming willpower, like financial advisors or diet meal plans. These industries wouldn’t exist if humans had absolute willpower. Behavioral economics gives researchers and regular people frameworks of understanding and potential solutions for their lack of self-control. For example, research has shown that the infamous DARE program, which encouraged students to use willpower and “Just Say No” to drugs, was ineffective. Instead, solutions that make an action harder to do (like moving junk food in cafeterias to a lower shelf, requiring more energy to reach) generate better results.
Finally, humans are always supposed to act in their own self-interest. One reason free-rider problems are supposed to be bad is because people aren’t expected to contribute to the good of the general public unless it helps them as individuals to do so. However, humans frequently act selflessly, whether that be through donating money to charity, volunteering their time, or acting out of spite to hurt others despite harming themselves in the process. Acting in the interest of others is one of the better ways in which we do not fit our economic definitions. Empathy has bettered countless lives over the thousands of years our species has existed.
Despite what some economists may want to believe, humans aren’t robots. We act and choose in ways that turn classic economic theory on its head, muting its effectiveness. Behavioral economists try to quantify those real-world quirks in the same way normal economists do — with rigorous experimentation and data analysis, which help us understand what real people do and why they do it. With these insights, we can modify policies, alter heuristics, and expose unconscious biases. And in contrast to much of classical economic theory, these conclusions take into account the uniqueness of human behavior.
