Analysis
Key Takeaway 1
Behavioral economics has caused, or has the potential to cause, a paradigm shift in economics.
Analysis
“Paradigm shift” is a term coined by philosopher Thomas Kuhn. Kuhn’s The Structure of Scientific Revolutions, published in 1972, argued that the conventional way of thinking about scientific progress was wrong. [1] Before Kuhn’s book was published, most people argued that science advanced by discovering new facts. In this way, the accretion of more and more facts allowed people to get a better and better picture of the way the world worked.
Kuhn argued that science doesn’t actually work this way. Instead, he said, scientists develop theories. These theories help scientist organize facts. Thus, the idea that the sun orbited the earth was used as the basis for models which accounted for many complexities of planetary motion. There will always be facts that don’t fit a theory, or that have to be explained away. Sometimes, however, Kuhn explained, these aberrant facts become so insistent that they lead to huge shifts in scientific theory—or to what Kuhn called paradigm shifts. In the case of the solar system, astronomers were confronted with so many contradictions to the geocentric model that the model was changed to have the earth orbiting the sun, and not vice versa. All the old facts took on new meaning in the new system.
Behavioral economics has the potential to cause such a paradigm shift in economics. Rather than looking at economic theory to describe human behavior, behavioral economics encourages economists to study human behavior in order to adjust and reinterpret economic theory. This can transform understanding of economic action, and allow economists to develop powerful new insights, improve people’s lives, and develop better governmental policies. For instance, behavioral economics could focus economists on studying how financial traders make decisions, which could help develop regulations to prevent future financial bubbles and collapses.
Key Takeaway 2
Traditional economic theory says that people make decisions rationally. The field of behavioral economics shows that this is wrong.
Analysis
In traditional economic theory, individuals are rational actors. Imagine that a rational economic actor, or an Econ, wanted to buy an awesome new Led Zeppelin box set. But the box set costs $250. The Econ knows she can’t afford the box set. She has a family. She needs to pay rent and buy groceries, and is behind on her credit card bill. No Led Zeppelin for her. But then, the Econ’s friend buys her the box set for her birthday. The good, rational Econ cheers to herself, and then she goes online and sells the box set for $250 to pay down her credit card bill and save money on interest. The birthday gift doesn’t change the Econ’s financial situation. She still can’t afford the box set.
Traditional economists look at the Econ’s actions and...