Economic Psychology
Lecture 1 Introduction
Academic Life: What do we do? Research 40% Teaching 60%
Economic Psychology studies:
“how individuals affect the economy and how the economy affects individuals.”
If most people think this is a bad time to buy a car→economy goes down because nobody buys a car. Big impact
If things are going bad in economy it has an impact on our lifestyle
International Association for Research in Economic Psychology (IAREP-1982, Tilburg):
‘To briefly summarize, Economic Psychology is an emergent discipline, informed by both disciplines, that leads to a better
understanding of people behaving in their economic lives, and that explores the way economic issues in society affect
people's behavior.’ →consumer decisions (1+1 bonus)
Journal of Economic Psychology→handbook (Behavioral Economics/Consumer Psychology/Economic Psychology)
Topics (IAREP) According to it we study:
‘It is concerned with issues of choice and decision-making. Economic Psychologists are also interested in such diverse
areas as environmental issues, token economies, experimental gaming, and time preferences.’
'Furthermore, it deals with the impact of external economic phenomena upon human behavior and wellbeing. These
studies may relate to different levels of aggregation: from the household and individual consumer to the macro level of
whole nations.'
Thinking like an Economic Psychologist
• Economics is a behavioral science! →making decisions to spend the money in the best way possible
• Develop an understanding of economic theory →rational decisions, economically right things to do to make decisions
often we deviate from the rational decision, but why? How can we explain people's behavior and predict it?
• Develop an economic perspective on everyday behavior
• Identify when and where economic theory fails • Learn alternative approaches to understand economic behavior
• Identify ways in which we can help people to make better choices (economic psychology→science of choices)
Ward Edwards (1927-2005)
THE THEORY OF DECISION MAKING →difficult article we will read→difficult economic decision making
What is an economic man like? He has three properties, (a) He is completely informed (know what to choose) (6) He is
infinitely sensitive (knows what's best for him, whether a product is better than the other, between a range of products,
need to make compromise), (c) He is rational.
Very expensive product to make the accessible range wider (vinegar for 2$, 4$, 10$ →10$ there only to make the range
wider, we will buy the vinegar)
It is easy for a psychologist to point out that an economic man who has the property discussed above is unlike a real man.
In fact, it is so easy to point this out that psychologists have tended to reject out of hand the theories that result from these
assumptions. This is not fair. (Know that the assumptions are wrong →Theory might be based on stupid assumptions, but
if it is a good predictor of behavior then it’s a good theory)
The most useful thing to do with a theory is not to criticize its assumptions, but rather to test its theorems. If the theorems
fit the data, then the theory has at least heuristic merit.
“At the core of behavioral economics is the conviction that increasing the realism of the psychological underpinnings of
economics analysis will improve the fields of economics on its own terms—generating theoretical insights, making better
predictions of field phenomena, and suggesting better policy.” (Camerer & Loewenstein, 2004, p. 3)
→If we understand the assumptions and can replace them with better properties then we create better theories
Herbert Simon (1916-2001)
If you really want to understand economic behavior you need to look at psychology under it.
Always optimize, go for the best decision, In real life we don’t do that, we usually go for the first good enough option, and
maybe later on we find a better one and we go for that, we don’t optimize but satisfy
What does psychology study→predictions, behavior, cognition (Controlla)
Illusion of circles that looks like a spiral→psychology is difficult, we see one thing and we perceive another
Going to the gym taking an escalator→demonstrates it’s really hard for psychologists to predict behavior when the
environment changes→first escalators→1897 Cony Island NY, 1898 Harrods London, 1926 Bijenkorf Den Haag
Before that people were staying more time alone and going to the local market, then in the multistore buildings the stores
were connected by stairs (traffic jam) If stairs move, less traffic, move people faster, earn more
1
,When they invented them they wanted people to walk on escalators as normal stairs to make them move faster, but
people started standing→ made it worse, needed more escalators→difficult to predict human behavior
Stable preferences→economic aspects we have stable preferences and we know our preferences, independently on how
we ask that. But people are lazy, many people don’t even take the effort to register/deregister. (for donations for example)
→reality is more complex than it looks like
More examples of Defaults
Whether you get a choice when you don’t choose. →defaults are really important
Enrollment rate in 401(k) plans is close to 100 % when enrollment is automatic, but if action is required to enroll, only
about 50% joins the plan within their first year of employment.
The cost of the activity is hardly sufficient to rationalize this behavior.
Urinal+Fly
In the early 1990s, the story goes, the cleaning manager at Schiphol Airport wanted to reduce “spillage” around
urinals. He settled on images of flies on the urinals, for men to aim at. (Guys aim better)
Why a fly? Aad Kieboom, the Schiphol Airport manager who oversaw the introduction of urinal flies: “a fly may have
unsanitary connotations, but that is exactly why nobody feels guilty aiming at it!”
Some claim that it can reduce spillage by up to 80% (Thaler & Sunstein, 2008).
Sphinx, produces of the toilets, says that the fly in the toilet represents savings in cleaning costs of 20% or more.
Schiphol is often cited as the source of studies done into spillage reduction, but it appears that no such studies have
taken place. Kieboom says that he was certainly never aware of any scientific research done into the effects of the fly, and
that the 80% figure was ‘very empirical’.
Nudge→Book about how behavioral sciences can be use to Improve decisions about health, wealth and happiness
Policy Implications of Economic Psychological Research
2015 World Bank: how psychology can inform policy making, to understand people’s behavior you need to consider it’s
not rational but is usually based on 3 principles (Book=Mind Society and Behavior) 3 Principles:
- choices often AUTOMATIC -We are SOCIAL ANIMALS -We use MENTAL MODELS
Automaticity→for example we can’t switch off reading, or automatic saving of money from your bank account every
month, save up a lot of money automatically
Do not swim while drunk→when drunk we don’t think of it anymore
Mental models→I’ll start going to the gym on monday, monday passes, next monday
Pay for the toilet→2 cents small penis, 2 euros big penis
Which job do you prefer?
A: You earn per year €50K, your direct colleagues €25K
B: You earn per year €100K, your direct colleagues €200K
Is more always better?: A survey on positional concerns
We use survey data to provide some empirical information about concerns regarding relative standing.
Mental Models
We respond not to objective truths but to how we see them, to our mental models
Some Simple Psychological Principles To keep in mind to influence people’s behavior and decision making)
1) Many Choices are Automatic (People do not always know what they want and why they do something)
2) People are Social Animals (It is not only about what you have, but also about what the other has)
3) People respond to Mental Models (there is not always an objective truth)
4) People are hard to mobilize (they are inert and do not optimize)
5) Small changes can have big effects (and these are not always easy to predict!)
2
,Lecture 2 A Little History of Economic Psychology
Think Economic Psychologically
• Economics is a behavioral science!
• Develop an understanding of economic theory
• Develop an economic perspective on everyday behavior
• Identify when and where economic theory fails
• Learn alternative approaches to understand economic behavior
• Identify ways in which we can help people to make better choices
Economic Psychology
• What is rationality? We want people to make rational decisions (different theories about rationality:)
• How should people make decisions? Normative / prescriptive theories (telling people what you should do-economics)
• How do people make decisions? Descriptive theories (describe how people make decisions - psychology)
→try to merge normative and descriptive theories (Can we make theories more plausible to understand what people do?)
Some Simple Psychological Principles
5) Small changes can have big effects (and these are not always easy to predict!) eg. escalator
Morton street in Manhattan 1893, looks dirty, there is a lot of horse shit, bring stuff to people’s houses by carriage with
horses, shit smells a lot, goes in the basements→Solution to save the environment→invention of the automobil→to clean
the air of Manhattan (now even more polluted, they thought cars were going to leave streets clean and solve pollution)
- Rewards may be counterproductive: The Cobra effect Horst Siebert (2001)
India→problems with snakes and cobras→Need to solve the problem→Promise a Bounty (money) for every cobra skin
(people killing the cobras) →but this didn’t solve the situation, people where making cobras reproduce and let them grow
to earn money→they decided not to give money for small Cobra skins→ people threw them in the forest→many more
cobras around (this not true, but this happened in Vietnam, where rats tails were exchanged for money to get rid of them)
Hard to predict behavior before it happens
- Punishment may be counterproductive: Uri Gneezy & Aldo Rustichini (2000, Journal of Legal Studies )
At daycare, it opens at 8 and closes at 18, if you’re not on time they wait for you and suggest you’re a bad parent because
you were late (immoral behavior). What happens if you put a fine so that people who are too late are punished?
Should make it less attractive to be late→What happened? Number of people coming too late increased in the group with
the fine (shouldn't happen according economics rules→nobody likes to be too late, but being on time went from a moral to
a financial decision→easily make up for it by paying (makes it more attractive→take back the fine→even later because
then it’s for free) →fine should be reasonable but still high
Newspaper→Taking care of a fake baby: Australia→Program to reduce teenage pregnancies→if we let teenage girls
taking care of a robot baby they will find out this is not what they want and will be more careful (in the NL-education)
Findings 57 (86%) of 66 eligible schools were enrolled into the trial and randomly assigned 1:1 to the intervention
(28 schools) or the control group (29 schools). Then, between Feb 1, 2003, and May 31, 2006, 1267 girls in the
intervention schools received the VIP programme while 1567 girls in the control schools received the standard health
education curriculum. Compared with girls in the control group, a higher proportion of girls in the intervention group
recorded at least one birth (97 [8%] of 1267 in the intervention group vs 67 [4%] of 1567 in the control group) or at least
one abortion as the first pregnancy event (113 [9%] vs 101 [6%]).
Interpretation The infant simulator-based VIP programme did not achieve its aim of reducing teenage pregnancy.
Girls in the intervention group were more likely to experience a birth or an induced abortion than those in the control
group before they reached 20 years of age.
→Economic reasoning behind this intervention→their thought=it’s no fun to have a baby
In colombia→can robotic babies help prevent teenage pregnancies→when teenagers, difficult period, you have a purpose
in your life→taking care of the baby gives you purpose in life, get attention of people, boyfriend/mom spends more time
with you→take back the baby because the study ends→they make a baby themself because they actually liked it
Economic Psychology Some Relevant History
Economic + Psychology (200y ago these fields didn’t exist)
Adam Smith (1723 – 1790) “Wealth of Nations” 1776
Father of Modern Economics (helped create economics)→how should we organize society in the most effective way
-Rational Economic Man -Self-Interest = good
-The Invisible Hand→ how self-interested individuals can promote the general benefit of a society at large.
3
, 1776: Wealth of Nations
“It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their
regard to their own interest." (Book 1, Chapter 2, Wealth of Nations)
→if you wanna eat dinner you need to buy food, and these people sell it to you not because they like you but to make
money→behavior that in the end is good for you (you get the food)
“Every individual is continually exerting himself to find out the most advantageous employment for whatever capital he can
command. It is his own advantage, indeed, and not that of the society which he has in view. (=self interest) But the study
of his own advantage naturally, or rather necessarily leads him to prefer that employment which is most advantageous to
the society.” (Book 4, Chapter 2, Wealth of Nations)
→imagine there’s only us in the world→need to create a new society→lot of people who like to eat bread, wanna buy it
from the person who knows how to bake it, someone else says I also know how to bake it→the more people baking
bread, the lower the price → get competition between them→ people seek opportunities to make money→Invisible
hand→preferences of people in society makes people to look for jobs useful for the people around them
(if you like white bread but everyone else likes dark bread→you produce dark bread→motivated to make
money=motivated to do things that are beneficial for other people, and profitable for you)
1759: Theory of Moral Sentiments
“How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the
fortune of others, and render their happiness necessary to him, though he derives nothing from it except the pleasure of
seeing it.” Not self interested→we are not super egoistic, seeing other people being happy also creates happiness for us,
not only by being beneficial for us but just making them happy
• Smith critically examines the moral thinking of his time, and suggests that conscience arises from social relationships
• Smith proposes a theory of sympathy, in which the act of observing others makes people aware of themselves and the
morality of their own behavior
→don’t steal from other people because makes us feel guilty→we would if we were fully self centered because we
wouldn’t care→more psychological theory
Empathy-Induced Altruism (Smith)
“The basic idea of the theory is not original with me. A relationship between empathic concern and altruism was
proposed earlier by social psychologist Dennis Krebs (1975) and by developmental psychologist Martin Hoffman
(1976), much earlier by psychologist William McDougall (1908), and even earlier by philosophers David Hume
(1740/1896) and Adam Smith (1759/1853).” →psychology in the origins of economic thinking
Think of yourself in that situation→Empathy
IAREP: Economic Psychology is concerned with issues of choice and decision-making.
Economic Psychologists are also interested in such diverse theoretical areas as, token economies, experimental gaming,
and time preferences; and societal issues such as: environmental issues, taxation, insurance, poverty, entrepreneurship.
Psychology & Economics: History
→Core of economics→how do people come up with decisions?
Blaise Pascal (1623-1662)
“the value of a future gain should be directly proportional to the chance of getting it”
Expected Value EV = p • x Calculate if your decision is going to bring you something positive→if it’s more
likely to get something you should value that more
Daniel Bernoulli ( 1700 Groningen-1782 Basel) + Nicolas I Bernoulli (1687 Basel -1759 Basel)
“St. Petersburg Paradox” & Utility
Utility→measure of pleasure→becomes the norm in that field
Jeremy Bentham (1748-1832) Moral Philosopher→how should we organize society to make most people most happy
We should make automata of smart people and make them teach all over the world, even after they die→holograms,
make a robot of himself. After he died he wanted to leave his library to the university on the condition he will be preserved
and still a member of the court (since then there was never consensus→he was dead, couldn't raise his hand, but when
he was alive he said he was always going for the most innovative idea)
Wrote about progressive taxation →we should transfer money from rich to poor people to make everyone happy
Cell house→need to isolate criminals→Prisoners should work to pay being in a prison, cheapest diet for them not to
starve but not to spend too much money→only one guard in the middle of the cell
In order to maximize, we need to be able to quantify and compare the amount of happiness/pleasure of possible acts.
4
Lecture 1 Introduction
Academic Life: What do we do? Research 40% Teaching 60%
Economic Psychology studies:
“how individuals affect the economy and how the economy affects individuals.”
If most people think this is a bad time to buy a car→economy goes down because nobody buys a car. Big impact
If things are going bad in economy it has an impact on our lifestyle
International Association for Research in Economic Psychology (IAREP-1982, Tilburg):
‘To briefly summarize, Economic Psychology is an emergent discipline, informed by both disciplines, that leads to a better
understanding of people behaving in their economic lives, and that explores the way economic issues in society affect
people's behavior.’ →consumer decisions (1+1 bonus)
Journal of Economic Psychology→handbook (Behavioral Economics/Consumer Psychology/Economic Psychology)
Topics (IAREP) According to it we study:
‘It is concerned with issues of choice and decision-making. Economic Psychologists are also interested in such diverse
areas as environmental issues, token economies, experimental gaming, and time preferences.’
'Furthermore, it deals with the impact of external economic phenomena upon human behavior and wellbeing. These
studies may relate to different levels of aggregation: from the household and individual consumer to the macro level of
whole nations.'
Thinking like an Economic Psychologist
• Economics is a behavioral science! →making decisions to spend the money in the best way possible
• Develop an understanding of economic theory →rational decisions, economically right things to do to make decisions
often we deviate from the rational decision, but why? How can we explain people's behavior and predict it?
• Develop an economic perspective on everyday behavior
• Identify when and where economic theory fails • Learn alternative approaches to understand economic behavior
• Identify ways in which we can help people to make better choices (economic psychology→science of choices)
Ward Edwards (1927-2005)
THE THEORY OF DECISION MAKING →difficult article we will read→difficult economic decision making
What is an economic man like? He has three properties, (a) He is completely informed (know what to choose) (6) He is
infinitely sensitive (knows what's best for him, whether a product is better than the other, between a range of products,
need to make compromise), (c) He is rational.
Very expensive product to make the accessible range wider (vinegar for 2$, 4$, 10$ →10$ there only to make the range
wider, we will buy the vinegar)
It is easy for a psychologist to point out that an economic man who has the property discussed above is unlike a real man.
In fact, it is so easy to point this out that psychologists have tended to reject out of hand the theories that result from these
assumptions. This is not fair. (Know that the assumptions are wrong →Theory might be based on stupid assumptions, but
if it is a good predictor of behavior then it’s a good theory)
The most useful thing to do with a theory is not to criticize its assumptions, but rather to test its theorems. If the theorems
fit the data, then the theory has at least heuristic merit.
“At the core of behavioral economics is the conviction that increasing the realism of the psychological underpinnings of
economics analysis will improve the fields of economics on its own terms—generating theoretical insights, making better
predictions of field phenomena, and suggesting better policy.” (Camerer & Loewenstein, 2004, p. 3)
→If we understand the assumptions and can replace them with better properties then we create better theories
Herbert Simon (1916-2001)
If you really want to understand economic behavior you need to look at psychology under it.
Always optimize, go for the best decision, In real life we don’t do that, we usually go for the first good enough option, and
maybe later on we find a better one and we go for that, we don’t optimize but satisfy
What does psychology study→predictions, behavior, cognition (Controlla)
Illusion of circles that looks like a spiral→psychology is difficult, we see one thing and we perceive another
Going to the gym taking an escalator→demonstrates it’s really hard for psychologists to predict behavior when the
environment changes→first escalators→1897 Cony Island NY, 1898 Harrods London, 1926 Bijenkorf Den Haag
Before that people were staying more time alone and going to the local market, then in the multistore buildings the stores
were connected by stairs (traffic jam) If stairs move, less traffic, move people faster, earn more
1
,When they invented them they wanted people to walk on escalators as normal stairs to make them move faster, but
people started standing→ made it worse, needed more escalators→difficult to predict human behavior
Stable preferences→economic aspects we have stable preferences and we know our preferences, independently on how
we ask that. But people are lazy, many people don’t even take the effort to register/deregister. (for donations for example)
→reality is more complex than it looks like
More examples of Defaults
Whether you get a choice when you don’t choose. →defaults are really important
Enrollment rate in 401(k) plans is close to 100 % when enrollment is automatic, but if action is required to enroll, only
about 50% joins the plan within their first year of employment.
The cost of the activity is hardly sufficient to rationalize this behavior.
Urinal+Fly
In the early 1990s, the story goes, the cleaning manager at Schiphol Airport wanted to reduce “spillage” around
urinals. He settled on images of flies on the urinals, for men to aim at. (Guys aim better)
Why a fly? Aad Kieboom, the Schiphol Airport manager who oversaw the introduction of urinal flies: “a fly may have
unsanitary connotations, but that is exactly why nobody feels guilty aiming at it!”
Some claim that it can reduce spillage by up to 80% (Thaler & Sunstein, 2008).
Sphinx, produces of the toilets, says that the fly in the toilet represents savings in cleaning costs of 20% or more.
Schiphol is often cited as the source of studies done into spillage reduction, but it appears that no such studies have
taken place. Kieboom says that he was certainly never aware of any scientific research done into the effects of the fly, and
that the 80% figure was ‘very empirical’.
Nudge→Book about how behavioral sciences can be use to Improve decisions about health, wealth and happiness
Policy Implications of Economic Psychological Research
2015 World Bank: how psychology can inform policy making, to understand people’s behavior you need to consider it’s
not rational but is usually based on 3 principles (Book=Mind Society and Behavior) 3 Principles:
- choices often AUTOMATIC -We are SOCIAL ANIMALS -We use MENTAL MODELS
Automaticity→for example we can’t switch off reading, or automatic saving of money from your bank account every
month, save up a lot of money automatically
Do not swim while drunk→when drunk we don’t think of it anymore
Mental models→I’ll start going to the gym on monday, monday passes, next monday
Pay for the toilet→2 cents small penis, 2 euros big penis
Which job do you prefer?
A: You earn per year €50K, your direct colleagues €25K
B: You earn per year €100K, your direct colleagues €200K
Is more always better?: A survey on positional concerns
We use survey data to provide some empirical information about concerns regarding relative standing.
Mental Models
We respond not to objective truths but to how we see them, to our mental models
Some Simple Psychological Principles To keep in mind to influence people’s behavior and decision making)
1) Many Choices are Automatic (People do not always know what they want and why they do something)
2) People are Social Animals (It is not only about what you have, but also about what the other has)
3) People respond to Mental Models (there is not always an objective truth)
4) People are hard to mobilize (they are inert and do not optimize)
5) Small changes can have big effects (and these are not always easy to predict!)
2
,Lecture 2 A Little History of Economic Psychology
Think Economic Psychologically
• Economics is a behavioral science!
• Develop an understanding of economic theory
• Develop an economic perspective on everyday behavior
• Identify when and where economic theory fails
• Learn alternative approaches to understand economic behavior
• Identify ways in which we can help people to make better choices
Economic Psychology
• What is rationality? We want people to make rational decisions (different theories about rationality:)
• How should people make decisions? Normative / prescriptive theories (telling people what you should do-economics)
• How do people make decisions? Descriptive theories (describe how people make decisions - psychology)
→try to merge normative and descriptive theories (Can we make theories more plausible to understand what people do?)
Some Simple Psychological Principles
5) Small changes can have big effects (and these are not always easy to predict!) eg. escalator
Morton street in Manhattan 1893, looks dirty, there is a lot of horse shit, bring stuff to people’s houses by carriage with
horses, shit smells a lot, goes in the basements→Solution to save the environment→invention of the automobil→to clean
the air of Manhattan (now even more polluted, they thought cars were going to leave streets clean and solve pollution)
- Rewards may be counterproductive: The Cobra effect Horst Siebert (2001)
India→problems with snakes and cobras→Need to solve the problem→Promise a Bounty (money) for every cobra skin
(people killing the cobras) →but this didn’t solve the situation, people where making cobras reproduce and let them grow
to earn money→they decided not to give money for small Cobra skins→ people threw them in the forest→many more
cobras around (this not true, but this happened in Vietnam, where rats tails were exchanged for money to get rid of them)
Hard to predict behavior before it happens
- Punishment may be counterproductive: Uri Gneezy & Aldo Rustichini (2000, Journal of Legal Studies )
At daycare, it opens at 8 and closes at 18, if you’re not on time they wait for you and suggest you’re a bad parent because
you were late (immoral behavior). What happens if you put a fine so that people who are too late are punished?
Should make it less attractive to be late→What happened? Number of people coming too late increased in the group with
the fine (shouldn't happen according economics rules→nobody likes to be too late, but being on time went from a moral to
a financial decision→easily make up for it by paying (makes it more attractive→take back the fine→even later because
then it’s for free) →fine should be reasonable but still high
Newspaper→Taking care of a fake baby: Australia→Program to reduce teenage pregnancies→if we let teenage girls
taking care of a robot baby they will find out this is not what they want and will be more careful (in the NL-education)
Findings 57 (86%) of 66 eligible schools were enrolled into the trial and randomly assigned 1:1 to the intervention
(28 schools) or the control group (29 schools). Then, between Feb 1, 2003, and May 31, 2006, 1267 girls in the
intervention schools received the VIP programme while 1567 girls in the control schools received the standard health
education curriculum. Compared with girls in the control group, a higher proportion of girls in the intervention group
recorded at least one birth (97 [8%] of 1267 in the intervention group vs 67 [4%] of 1567 in the control group) or at least
one abortion as the first pregnancy event (113 [9%] vs 101 [6%]).
Interpretation The infant simulator-based VIP programme did not achieve its aim of reducing teenage pregnancy.
Girls in the intervention group were more likely to experience a birth or an induced abortion than those in the control
group before they reached 20 years of age.
→Economic reasoning behind this intervention→their thought=it’s no fun to have a baby
In colombia→can robotic babies help prevent teenage pregnancies→when teenagers, difficult period, you have a purpose
in your life→taking care of the baby gives you purpose in life, get attention of people, boyfriend/mom spends more time
with you→take back the baby because the study ends→they make a baby themself because they actually liked it
Economic Psychology Some Relevant History
Economic + Psychology (200y ago these fields didn’t exist)
Adam Smith (1723 – 1790) “Wealth of Nations” 1776
Father of Modern Economics (helped create economics)→how should we organize society in the most effective way
-Rational Economic Man -Self-Interest = good
-The Invisible Hand→ how self-interested individuals can promote the general benefit of a society at large.
3
, 1776: Wealth of Nations
“It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their
regard to their own interest." (Book 1, Chapter 2, Wealth of Nations)
→if you wanna eat dinner you need to buy food, and these people sell it to you not because they like you but to make
money→behavior that in the end is good for you (you get the food)
“Every individual is continually exerting himself to find out the most advantageous employment for whatever capital he can
command. It is his own advantage, indeed, and not that of the society which he has in view. (=self interest) But the study
of his own advantage naturally, or rather necessarily leads him to prefer that employment which is most advantageous to
the society.” (Book 4, Chapter 2, Wealth of Nations)
→imagine there’s only us in the world→need to create a new society→lot of people who like to eat bread, wanna buy it
from the person who knows how to bake it, someone else says I also know how to bake it→the more people baking
bread, the lower the price → get competition between them→ people seek opportunities to make money→Invisible
hand→preferences of people in society makes people to look for jobs useful for the people around them
(if you like white bread but everyone else likes dark bread→you produce dark bread→motivated to make
money=motivated to do things that are beneficial for other people, and profitable for you)
1759: Theory of Moral Sentiments
“How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the
fortune of others, and render their happiness necessary to him, though he derives nothing from it except the pleasure of
seeing it.” Not self interested→we are not super egoistic, seeing other people being happy also creates happiness for us,
not only by being beneficial for us but just making them happy
• Smith critically examines the moral thinking of his time, and suggests that conscience arises from social relationships
• Smith proposes a theory of sympathy, in which the act of observing others makes people aware of themselves and the
morality of their own behavior
→don’t steal from other people because makes us feel guilty→we would if we were fully self centered because we
wouldn’t care→more psychological theory
Empathy-Induced Altruism (Smith)
“The basic idea of the theory is not original with me. A relationship between empathic concern and altruism was
proposed earlier by social psychologist Dennis Krebs (1975) and by developmental psychologist Martin Hoffman
(1976), much earlier by psychologist William McDougall (1908), and even earlier by philosophers David Hume
(1740/1896) and Adam Smith (1759/1853).” →psychology in the origins of economic thinking
Think of yourself in that situation→Empathy
IAREP: Economic Psychology is concerned with issues of choice and decision-making.
Economic Psychologists are also interested in such diverse theoretical areas as, token economies, experimental gaming,
and time preferences; and societal issues such as: environmental issues, taxation, insurance, poverty, entrepreneurship.
Psychology & Economics: History
→Core of economics→how do people come up with decisions?
Blaise Pascal (1623-1662)
“the value of a future gain should be directly proportional to the chance of getting it”
Expected Value EV = p • x Calculate if your decision is going to bring you something positive→if it’s more
likely to get something you should value that more
Daniel Bernoulli ( 1700 Groningen-1782 Basel) + Nicolas I Bernoulli (1687 Basel -1759 Basel)
“St. Petersburg Paradox” & Utility
Utility→measure of pleasure→becomes the norm in that field
Jeremy Bentham (1748-1832) Moral Philosopher→how should we organize society to make most people most happy
We should make automata of smart people and make them teach all over the world, even after they die→holograms,
make a robot of himself. After he died he wanted to leave his library to the university on the condition he will be preserved
and still a member of the court (since then there was never consensus→he was dead, couldn't raise his hand, but when
he was alive he said he was always going for the most innovative idea)
Wrote about progressive taxation →we should transfer money from rich to poor people to make everyone happy
Cell house→need to isolate criminals→Prisoners should work to pay being in a prison, cheapest diet for them not to
starve but not to spend too much money→only one guard in the middle of the cell
In order to maximize, we need to be able to quantify and compare the amount of happiness/pleasure of possible acts.
4
