Introduction to Behavioral

xii

heuristics and biases. The expansion has been caused by several factors: (1) there has 

been a large amount of relevant research over the last four years, requiring substantial 

updating of much material; (2) there were some signifi cant omissions in the fi rst 

edition which needed to be rectifi ed, and many of these were drawn to our attention 

by reviewers, to whom we are most grateful; (3) experience of teaching various 

courses in behavioral economics over the last few years has prompted us to change 

the presentation of some materials for pedagogical reasons; and (4) additional rigor of 

analysis has been provided in certain areas.

In summary, the intention is to provide a book which is comprehensive, rigorous 

and up-to-date in terms of reviewing the latest developments in the fi eld of behavioral 

economics; cross-disciplinary in approach; and user-friendly in terms of exposition, 

discussing a large number of examples and case studies to which the reader can relate. 

Typically three case studies are included at the end of each chapter, with questions 

reviewing the relevant material. 

It is also appropriate here to give a note of apology: readers may fi nd  some 

repetitiveness in the materials in the various chapters. We offer the following excuses. 

Some readers or instructors may wish to skip certain chapters, like the more technical 

chapter on game theory. Also, many of the themes in different chapters are linked, with 

the features of prospect theory and mental accounting in particular applying in many 

different areas. As a fi nal point, it seems appropriate to hammer home certain points 

of behavioral analysis, especially when these are at variance with other commonly-held 

theories or beliefs.

Lastly, some words of thanks are in order regarding several people who have 

helped to improve this edition of the book. Matthew Rablen, from Brunel University, 

invited the fi rst author to share the teaching of a course in behavioral economics, and 

discussions with him have aided various aspects, notably the mathematical exposition 

in the text. The students there, and at other institutions, have also made various 

suggestions and contributions. In particular, we would like to thank Thomas Matura 

for drawing attention to the phenomenon of celebrity contagion. Finally, we would like 

to thank our anonymous reviewers for their comments and suggestions, which have 

allowed us to improve the text in many respects. Of course, any remaining inaccuracies 

and oversights are the sole responsibility of the authors. 

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xiii

 

Acknowledgments

The following publishers kindly granted permission to reprint the material that appears in the book.

The Economist

Loss aversion in monkeys (23/06/05)

The joy of giving (12/10/06)

Pursuing happiness (29/06/06)

Do economists need brains? (24/07/08)

The way the brain buys (18/12/08)

Fakes and honesty (24/06/10)

Too good to live (19/08/10)

The American Economic Association

Fehr, E., and  Gächter, S. (2001). Fairness and retaliation. 

Journal of Economic Perspectives, 3, 

Figure 2, 167.

Frederick, S., Loewenstein, G., and O’Donoghue, T. (2002). Time discounting and time preference: 

A critical review. 

Journal of Economic Literature, 40(2), Table 1, 378–9.   

Cambridge University Press

Camerer, C.F. (2000). Prospect theory in the wild: Evidence from the fi eld. In D. Kahneman and 

A. Tversky (Eds), 

Choices, Values, and Frames, Table 16.1, 289.

Princeton University Press

Camerer, C.F. (2003). Behavioral Game Theory, Table 6.3, 272.

OECD

OECD (2003). Gross private savings rates. 

OECD Economic Studies, 36 (1), Figure 1, 120. 

We should also like to thank the following authors for granting personal permission to reproduce 

their work:

Colin Camerer, Ernst Fehr, Shane Frederick, Simon Gächter, George Loewenstein and Ted 

O’Donoghue.

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PART

•

I

  

Introduction

---

1

Nature of Behavioral Economics

1.1  Behavioral economics and the standard model 

2

 

What is behavioral economics? 

2

 Economic 

rationality 

3

 

Behavioral perspectives on economic rationality 

8

 

Nature of the standard model 

10

 

Applicability of the standard model 

11

1.2  History and evolution of behavioral economics 

12

 

The classical and neoclassical approaches 

13

 

Post-war economic approaches 

13

 

The resurgence of behaviorism in economics 

14

1.3  Relationship with other disciplines 

15

 Evolutionary 

biology 

15

 Cognitive 

neuroscience 

17

1.4  Objectives, scope and structure 

19

 Objectives 

 

19

 Structure 

 

19

1.5 Summary 

 

20

1.6 Review 

questions 

20

1.7 Applications 

 

20

 

Case 1.1 

Loss aversion in monkeys 

21

 

Case 1.2 

Money illusion   

23

 

Case 1.3 

Altruism – the joy of giving 

26

CHAPTER

•

1

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