Introduction to Behavioral

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1.5 Summary

•  Behavioral economics is concerned with improving the explanatory power of 

economic theories by giving them a sounder psychological basis.

• 

Behavioral economics relaxes key assumptions of the standard model in order to 

explain a wide variety of anomalies in that model.

• 

Behavioral economics is a relatively new discipline, becoming recognized around 

1980; before that time psychology had largely been ignored by economists for 

many decades.

•  Behavioral economists use a variety of methods or approaches, based on both 

traditional economics and psychology, and also borrowing from those commonly 

used in other sciences as well. Thus both observational and experimental studies 

are used, and sometimes computer simulations and brain scans. This relates to the 

concept of consilience.

•  There are various methodological issues related to the behavioral approach, 

and in particular to the application of related disciplines – such as evolutionary 

psychology and cognitive neuroscience – to economics.

•  Evolutionary biology and psychology are best viewed in terms of the broader 

concept of gene-culture coevolution.

• 

Rationality can be defi ned in a number of ways. In economics, a standard model of 

economic rationality is used but is subject to considerable variation depending on

context and sub-discipline.

1.6  Review questions

1  What is behavioral economics?

2  Summarize the assumptions of the standard economic model.

3  Give four examples of phenomena that cannot be explained by the standard model.

4  Explain what is meant by evolutionary psychology and why it is related to behavioral 

economics.

5  Explain the difference between a descriptive and a normative theory.

1.7  Applications

Three situations where behavioral economics can be usefully applied are now presented. 

In each case it is not appropriate at this stage to engage in a detailed discussion of 

the issues involved, since these are examined in the remainder of the book; instead a 

summary of the important relevant behavioral issues is given in outline form. However, 

these applications should serve to give the reader a fl avor of what behavioral economics 

is about in general terms.

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Case 1.1  Loss aversion in monkeys 

Monkeys show the same “irrational” aversion to risks as humans

ECONOMISTS often like to speak of Homo economicus — rational economic man. In practice, 

human economic behaviour is not quite as rational as the relentless logic of theoretical 

economics suggests it ought to be. When buying things in a straight exchange of money for 

goods, people often respond to changes in price in exactly the way that theoretical economics 

predicts. But when faced with an exchange whose outcome is predictable only on average, 

most people prefer to avoid the risk of making a loss than to take the chance of making a gain 

in circumstances when the average expected outcome of the two actions would be the same. 

There has been a lot of discussion about this discrepancy in the economic literature — in 

particular, about whether it is the product of cultural experience or is a refl ection of a deeper 

biological phenomenon. So Keith Chen, of the Yale School of Management, and his colleagues 

decided to investigate its evolutionary past. They reasoned that if they could fi nd similar 

behaviour in another species of primate (none of which has yet invented a cash economy) 

this would suggest that loss-aversion evolved in a common ancestor. They chose the capuchin 

monkey, Cebus apella, a South American species often used for behavioural experiments.

First, the researchers had to introduce their monkeys to the idea of a cash economy. They did 

this by giving them small metal discs while showing them food. The monkeys quickly learned 

that humans valued these inedible discs so much that they were willing to trade them for 

scrumptious pieces of apple, grapes and jelly.

Preliminary experiments established the amount of apple that was valued as much as either a 

grape or a cube of jelly, and set the price accordingly, at one disc per food item. The monkeys 

were then given 12 discs and allowed to trade them one at a time for whichever foodstuff they 

preferred. 

Once the price had been established, though, it was changed. The size of the apple portions 

was doubled, effectively halving the price of apple. At the same time, the number of discs a 

monkey was given to spend fell from 12 to nine. The result was that apple consumption went 

up in exactly the way that price theory (as applied to humans) would predict. Indeed, averaged 

over the course of ten sessions it was within 1% of the theory’s prediction. One up to Cebus 

economicus.

The experimenters then began to test their animals’ risk-aversion. They did this by offering them 

three different trading regimes in succession. Each required choosing between the wares of 

two experimental “salesmen”. In the fi rst regime one salesman offered one piece of apple for a 

disc, while the other offered two. However, half the time the second salesman only handed over 

one piece. Despite this deception, the monkeys quickly worked out that the second salesman 

offered the better overall deal, and came to prefer him.

In the second trading regime, the salesman offering one piece of apple would, half the 

time, add a free bonus piece once the disc had been handed over. The salesman offering 

two pieces would, as in the fi rst regime, actually hand over only one of them half the time. 

In this case, the average outcome was identical, but the monkeys quickly reversed their 

behaviour from the fi rst regime and came to prefer trading with the fi rst salesman.

 

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