Knowing and Making

If conventional economic theory is so wrong (as we are repeatedly told ) why does it survive so well? This post by UnlearningEcon  prompted me to think again about why economics, despite widely accepted empirical data from behavioural econ, is broadly taught in the same way as before, and why its basic assumptions still underpin much modern research. Some have a sociological explanation for this. In this view, economists are invested in the old approaches, have spent decades honing specific mathematical skills, and effectively collude to make sure new ideas do not displace the old. The top journals only accept papers that cite the same old work, perpetuating the models. Science, as they say, advances one funeral at a time. No doubt there's something to this, but I don't think economists are quite so closed minded. There is a clue in the above article: "...Euclidean geometry, despite being incorrect, is more effective than non-Euclidean geometry in some engineerin...

Eric Falkenstein has an interesting post  which highlights some of the problems in the study of behavioural economics (in this case, behavioural finance). I have to agree with his premise, though my conclusions are a bit different. I've just reread some of Nudge  and am partway through Animal Spirits . Both books cheerlead for the behavioural cause - though in each case, one author - Thaler and Shiller respectively - seem to be much more closely associated with it than the other - Sunstein and Akerlof. However both books exemplify the problem that Falkenstein identifies. The field is full of effects without explanations. You can easily list a whole string of cognitive biases which can be easily demonstrated - I show the effect directly to audiences in presentations, by running a price anchoring experiment. But the behaviourists rarely seem to propose a good underlying model of how these effects arise. Having just completed another book, The Making of an Economics, Redux , I can see...

The motivation principle : People act in their best interest, in the light of the information available to them, over a time period that they can accurately foresee. The first two of these statements seem relatively obvious but perhaps the third is not so clear. It means that people will not take an action today, for some nebulous potential benefit one day in the future. They must gain something in return for the action either immediately, or within a time horizon that they can clearly grasp. How long is that? If I make a calm and considered decision, the time horizon may be as much as a few hours; while in the heat of the moment it may only be a few seconds. Either way, in order to act in my longer-term interest, I must get some kind of short-term payoff or else it's too easy to sell out on my decision. For example, if I want to lose ten pounds and be able to run a marathon in six months, I won't succeed unless I give myself incentives that keep paying off for all those early ...