Behavioral economics enriches the conventional economics toolbox by incorporating insights from psychology, neuroscience, sociology, politics, and the law. The result: more vibrant and revealing economic analyses based on more realistic assumptions about how individuals behave in the real world and the real-world circumstances that influence the decisions they make.
| Conventional Economics Says . . . | Behavioral Economics Says . . . |
|---|---|
| For economic analysis, the assumptions made about people don’t have to be realistic. | For economic analysis, the assumptions made about people must be realistic. |
| People are endowed with the capacity to efficiently and effectively acquire and process all relevant information. | People are not endowed with the capacity to efficiently and effectively acquire and process all relevant information. People are referred to as being boundedly rational — they do the best they can, given the constraints they face. |
| People can figure out and factor in the future consequences of current decisions. | People aren’t always able to figure out the future consequences of current decisions, especially in a world of uncertainty (in other words, the real world). |
| People always make smart decisions, ones that they don’t regret. | People can and often do make decisions they end up regretting. |
| People always make decisions in an ideal decision-making environment, where they have all the information they need and the time to make the best possible decision. | People often face decision-making environments that prevent them from making the best possible choices. |
| Wealth and income maximization are all that matter. | Wealth and income maximization aren’t the only things that matter. Being fair, doing the right thing, maintaining a good reputation, and pleasing friends, neighbors, and partners are also important, even if they come at the expense of some wealth or income. |
| Relative positioning isn’t important. It doesn’t matter how much money your neighbor makes; all that matters is how much you make. | Relative income can be as important to people’s happiness as absolute income. People derive happiness from earning more than other people do. |
| People aren’t influenced by anyone or anything else. | People are influenced by their peers, by their past, and by their circumstances. |
| People are narrowly self-interested, and this is the only rational way to be. | Many people are narrowly self-interested, but altruism and ethics also can be important motivators for behavior. |
| How hard and well people work is assumed to be fixed, usually at some maximum point. Therefore, people don’t change how hard they work and productivity can’t be affected by the work environment. | How hard and well people work is determined by their work environment and by their individual preferences. As a result, productivity, costs, and prices can be affect by the work environment. |
| People are pretty much all the same. | People are different, with different tastes and preferences. |
| Markets are efficient, even if they appear to be inefficient. Efficiency is everywhere. | Markets can be highly inefficient, and if they look inefficient, they probably are. |