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Behavioural Economics

Background of Behavioural Economics

The behavioural approach to economics emerged in the 1960s partly as a response to neoclassical theory with its paradigm of rational behaviour and rational expectations. Whereas market outcomes are often close to those predicted by theories based on rationality, in important other instances anomalies occur (e.g. the current financial crisis) that strongly challenge the rationality assumption.

Lab experiments and cooperation with other sciences 

Stimulated by laboratory experiments in which individual behaviour can be carefully monitored in a controlled environment, economists started taking insights from other social sciences (such as psychology and sociology) seriously. At the same time, evolutionary foundations for economic behaviour were sought in collaboration with biologists. This new interdiscip­linary approach was quickly labeled ‘Behavioural Economics’.

Analysis of economic behaviour

The development of this field has also marked a broadening of economists’ interests beyond markets per se. This allows for a rigorous analysis of other economic behaviour, such as decision-making under risk and uncertainty, political-economic behaviour or the effects of social norms. For practical purposes, Behavioural Economics has proven to be important in designing mechanisms for a broad variety of applications, including auctions, voting rules and charity drives.

Theoretical and empirical research

Since its emergence the field has continuously grown in importance. All major academic journals in economics now regularly publish papers in this field. This literature addresses many interesting questions that are directly relevant for under­standing how markets really work and why market crises occur. Examples of the questions asked by researchers in this research priority area are:

  • In what circumstances are people more likely to compete and when do they prefer to cooperate?
  • What is the role of trust and trustworthiness in economic interactions?
  • How do remuneration practices in the labour market (like performance related rewards) influence the functioning of other (e.g. financial) markets?
  • How do strategies in financial markets evolve and what strategies are most likely to be successful?
  • To what extent is economic behaviour hard-wired and a consequence of evolutionary selection?
  • What effects does bounded human rationality have on the functioning of institutions like auctions, financial markets and voting mechanisms?

Such questions are addressed both theoretically and empirically, in the latter case often using controlled laboratory or field experiments.