Economics Redux

Economics as a discipline may be on the verge of changing. Economics has long held to a belief that individual economic actors - be they individuals or corporations - are rational in there choices and actions. This assumption is not only a very strong one that has profound and fundamental impacts on all economic theories that adopt it, but it is also very convenient from a modeling and forecasting point of view. If we assume that all economic "actors" are rational that means, at its most basic level, that they evaluate all available information weighing costs and benefits and then select the action that maximizes the benefits per unit of cost. This is a very powerful assumption because it means that from a theoretical and mathematical point of view all the economist has to do is decide on what information is available and assign costs and benefits to the choices. Then arithmetic can determine the outcome or steady-state. There are obviously other issues with this approach aside from this assumption: not everyone views the costs and benefits the same, information is imperfect, and there exist time constraints on decisions just to name a few. Putting these aside there is another glaring problem with today's economic models - people are not strictly speaking rational.

The issue is that virtually every single human being is influenced to various degrees by their emotions and the emotions of those around them. It is likely true that the vast majority of us would make very rational choices when presented with simple clear cut costs and benefits - unfortunately this simply doesn't happen. Our emotions, perceptions, and attitudes greatly impact our decision making. Recognizing this one single fact shakes the foundations of virtually all mainstream economic models. Suddenly psychology and behavioral analysis become important factors in determining how someone will react to an economic choice instead of just cost/benefit analysis.

Behavioral economics is a new and growing field that attempts to work the eccentricities of the human psyche into economic models to allow us to better model the real world and predict behavior. If economics as a discipline can make this shift I believe it will go a long way to making economics more intuitive to the general public and restore economists credibility.