The psychology of economic behaviour
Meeting 1: Thinking like an economist
Aim of this course: understand (economic) behaviour that goes beyond saving, interest rates etc.
=> underlying psychological mechanisms
5 readings for this meeting!
Assumption in economics: people make perfect choices comparing all alternatives and using info
to decide.
Article 1: How do economists think? (Eric van Dijk)
Adam Smith (1776): ‘Grounding father economics’
He wrote books (e.g. Wealth of Nations) and introduced concepts.
View of the book ‘Wealth of Nations’: only care about oneself, not about society. This is best for
society. That was the (almost normative) view the field had at that time.
Concept Adam Smith introduced:
- The Rational Economic Man (REM).
There is a market mechanism that steers it all => If all actors would be rational (only care about one’s
own outcomes) that would be good for society, e.g. no unemployment.
The REM is an agent who figures out how to maximize own outcomes.
- The invisible hand
Carl Menger (1871): ‘Grundsätze’ - Came later than Adam Smith.
Carl Menger introduced utility and motives at some point (psychology!)
- Utility: how good you feel about something depends per person.
E.g. for Eric van Dijk, SPA bottle has more utility (interest) than for me.
- Motives: Looks like Maslow’s survival pyramid => Move from level to level when satisfying needs.
Menger was way before Maslow, so he may be the superior to Maslow.
In Menger’s ideas, levels can be met at the same time. You don’t have to completely fulfill one level
(e.g. Food) to move to the next (tobacco) already.
Micro-economics
Is about the individual decision-making.
The rational economic man:
> Preferences : What would you like? Assumed to have stable preferences
> is greedy: ‘more is better’
> Income: What can you afford (budget)? & succeeds in maximizing its utility
> Prizes: What does st cost?
> Selfish and only cares about own outcomes (not of that of others) => Adam Smith
> Non-emotional
Preferences (stable): Indifference curves (ISO utility curve)
Example: two products; books and CD’s (mapping preferences)
Map preference: yellow lines => indifference curves (indifferent on all combinations on 1 curve)
Indifference: products that have the same utility, equally attractive to the decision maker.
More of one should be less of another product to be equally happy.
It flattens: You are very reluctant to give up even one page of a book, than CDs. More utility books
than CDs, if you already have many CDs.
1
, Properties indifference curve:
1. Away from 0: Higher utility – the further an indifference curve is from the origin, the more utility
2. Negative slope: Substitution
3. Convex to 0: The more X you have, the less value you put on increasing X (the less of Y you want to
give up for that) So, the more CD’s someone has, the less willing you are to give in on books to get
even more CDs as you already have them.
Income: what can you afford?
Budget line: you can buy any combination up to the red
line or below.
If you are a maximizer, you want the highest point (at
5/5). So the ISO-utility curve (yellow line) is set at the
highest one can reach.
But decisions can also be made differently; habit, laziness, lifestyle => different from rationality!
Rational Economic Man (REM) (idea Adam Smith – maximize own outcome)
Characteristics:
- Information: how to deal with vast amounts of information – weighing alternatives.
psychology: limited information processing, people can’t deal with vast amounts.
- Maximizing: nation of maximization (wanting the highest)
Psychology: dealing with uncertainty, the difficulty of predicting
- Self-interest (greed): do we only care about oneself?
Psychology: It can be your own interest to know st from others/fairness/altruism.
- Stable preferences
Psychology: Instable preferences (change easily)
- No emotions
Psychology: emotions do matter in decision-making.
=> Each lecture will discuss these topics from a psychological (economic) perspective.
Dealing with information
Article 2: Choice overload – demotivating (Iyengar & Lepper, 2000)
Assumption economics: the more choice, the better
What if we have too much choice?
“Pick product to your liking from many choices” (e.g. 75 olive oils, 300 jams) = impossible!
So, how do you choose? highest utility to you.
It seems that people tend to simplify their decisions by relying on simple heuristics.
Choice overload hypothesis: Although the provision of extensive choices may sometimes still be seen
as initially desirable, it may also prove unexpectedly demotivating in the end.
The present studies tested the hypothesis that having a limited and more manageable set of choices
may be more intrinsically motivating than having an overly extensive set of choices.
2
Meeting 1: Thinking like an economist
Aim of this course: understand (economic) behaviour that goes beyond saving, interest rates etc.
=> underlying psychological mechanisms
5 readings for this meeting!
Assumption in economics: people make perfect choices comparing all alternatives and using info
to decide.
Article 1: How do economists think? (Eric van Dijk)
Adam Smith (1776): ‘Grounding father economics’
He wrote books (e.g. Wealth of Nations) and introduced concepts.
View of the book ‘Wealth of Nations’: only care about oneself, not about society. This is best for
society. That was the (almost normative) view the field had at that time.
Concept Adam Smith introduced:
- The Rational Economic Man (REM).
There is a market mechanism that steers it all => If all actors would be rational (only care about one’s
own outcomes) that would be good for society, e.g. no unemployment.
The REM is an agent who figures out how to maximize own outcomes.
- The invisible hand
Carl Menger (1871): ‘Grundsätze’ - Came later than Adam Smith.
Carl Menger introduced utility and motives at some point (psychology!)
- Utility: how good you feel about something depends per person.
E.g. for Eric van Dijk, SPA bottle has more utility (interest) than for me.
- Motives: Looks like Maslow’s survival pyramid => Move from level to level when satisfying needs.
Menger was way before Maslow, so he may be the superior to Maslow.
In Menger’s ideas, levels can be met at the same time. You don’t have to completely fulfill one level
(e.g. Food) to move to the next (tobacco) already.
Micro-economics
Is about the individual decision-making.
The rational economic man:
> Preferences : What would you like? Assumed to have stable preferences
> is greedy: ‘more is better’
> Income: What can you afford (budget)? & succeeds in maximizing its utility
> Prizes: What does st cost?
> Selfish and only cares about own outcomes (not of that of others) => Adam Smith
> Non-emotional
Preferences (stable): Indifference curves (ISO utility curve)
Example: two products; books and CD’s (mapping preferences)
Map preference: yellow lines => indifference curves (indifferent on all combinations on 1 curve)
Indifference: products that have the same utility, equally attractive to the decision maker.
More of one should be less of another product to be equally happy.
It flattens: You are very reluctant to give up even one page of a book, than CDs. More utility books
than CDs, if you already have many CDs.
1
, Properties indifference curve:
1. Away from 0: Higher utility – the further an indifference curve is from the origin, the more utility
2. Negative slope: Substitution
3. Convex to 0: The more X you have, the less value you put on increasing X (the less of Y you want to
give up for that) So, the more CD’s someone has, the less willing you are to give in on books to get
even more CDs as you already have them.
Income: what can you afford?
Budget line: you can buy any combination up to the red
line or below.
If you are a maximizer, you want the highest point (at
5/5). So the ISO-utility curve (yellow line) is set at the
highest one can reach.
But decisions can also be made differently; habit, laziness, lifestyle => different from rationality!
Rational Economic Man (REM) (idea Adam Smith – maximize own outcome)
Characteristics:
- Information: how to deal with vast amounts of information – weighing alternatives.
psychology: limited information processing, people can’t deal with vast amounts.
- Maximizing: nation of maximization (wanting the highest)
Psychology: dealing with uncertainty, the difficulty of predicting
- Self-interest (greed): do we only care about oneself?
Psychology: It can be your own interest to know st from others/fairness/altruism.
- Stable preferences
Psychology: Instable preferences (change easily)
- No emotions
Psychology: emotions do matter in decision-making.
=> Each lecture will discuss these topics from a psychological (economic) perspective.
Dealing with information
Article 2: Choice overload – demotivating (Iyengar & Lepper, 2000)
Assumption economics: the more choice, the better
What if we have too much choice?
“Pick product to your liking from many choices” (e.g. 75 olive oils, 300 jams) = impossible!
So, how do you choose? highest utility to you.
It seems that people tend to simplify their decisions by relying on simple heuristics.
Choice overload hypothesis: Although the provision of extensive choices may sometimes still be seen
as initially desirable, it may also prove unexpectedly demotivating in the end.
The present studies tested the hypothesis that having a limited and more manageable set of choices
may be more intrinsically motivating than having an overly extensive set of choices.
2
