The Psychology of Economic Behavior
Lecture 1 | Thinking like an economist
Microeconomics
Adam Smith (1776) wrote the important book ‘The wealth of nations’ which has made a field
of Economics.
The rational-economic man makes decisions based on the rational analysis of potential and
desired outcomes and acts in his or her own rational self-interest. Humans are only guided by
our own interest and try to maximize their own outcomes.
The invisible hand is a metaphor for how, in a free market economy, self-interested
individuals operate through a system of mutual interdependence. This interdependence
incentivizes producers to make what is socially necessary, even though they may care only
about their own well-being.
a Everyone only pursues self-interest, but thereby collectively create prosperity.
An example
A business owner, seeking only to make themselves better off, might sell an item of higher
quality and at a lower price than his competitors. Keeping prices low may increase demand
and create competition among other suppliers offering similar products.
“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. But the study of his own advantage naturally, or rather
necessarily leads him to prefer that employment which is most advantageous to the society.”
If every economic actor only thinks about what is best for itself, the economy will be perfect,
and the market will solve potential problems itself.
Carl Menger (1871) published the book ‘Grundsätze der Volkswirtschaftslehre’ in which he
introduced two psychological concepts to the field of economics:
- Utility
A term used to determine the worth or value of a good or service. More specifically, it
is the total satisfaction or benefit derived from consuming a good or service.
Something can have utility for one, but not for the other; it is subjective.
- Motives
Something that causes us to act or behave in order to reach a goal or desired endpoint.
A motive is the reason why you do something.
Menger contributed to the development of the theories of marginalism and marginal utility.
- Marginalism is a theory that asserts individuals make decisions on the purchase of an
additional unit of a good or service based on the additional utility they will receive from
it.
- Marginal utility is the added satisfaction that a consumer gets from having one more
unit of a good or service. This concept is used by economists to determine how much
of an item consumers are willing to purchase.
1
,Menger’s view on life, food, and tobacco:
The columns represent different kinds of
wants, in the order of their importance; the
numbers in any column represent successive
want-satisfactions from unit increases of the
stock of goods satisfying that want-in modern
terms, the "marginal" utilities.
The first five columns may represent food; column V represents tobacco. Ten units of "food"
represent the individual's need for food.
The first thing you are motivated for to require is food. When you are satisfied, you go to
another level; food 2, food 3, and food 4. After satisfied of all levels of food, you go on to the
next level; tobacco 5.
To predict which decisions the rational consumer makes, we have to know something about:
• Preferences | indifference curves
• Income | budget line
• Prices | budget line
Preferences: indifference curves
Properties of an indifference curve:
1. Away from 0 = higher 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).
If you have 1000 CDs and 50 books, you will not
give up many books for 1 CD.
Budget line: income & prices
2
, Utility maximization = the concept that individuals and organizations seek to attain the
highest level of satisfaction from their economic decisions.
The rational economic man:
• Has all the information needed to make a rational choice
• Maximizes utility
• Is self-interested (greed)
• Has stable preferences
• Has no emotions
Greed
Greed = an intense and selfish desire for something (especially wealth, power, or food). It is
about wanting more and more and more.
Greed is correlated with, but different from:
- Maximizing
- Materialism
- Self-interest
Study by Hoyer et al. (2022)
This was a correlational study where greed and self-interest were measured. They found
correlations with:
• Economic outcomes
Personal & household income.
• Evolutionary outcomes
# children, longest relation, # sexual partners.
• Psychological outcomes
Satisfaction with life.
Social value orientation is a person’s preference about how to allocate resources (e.g. money)
between the self and another person. It corresponds to how much weight a person attaches
to the welfare of others in relation to the own.
According to studies:
• Men are more greedy
• Younger people are more greedy
Those who scored high on greed, have:
- A higher household income
But not personal.
- Fewer children
- More sexual partners
Not after controlling for age.
- Shorter relationships
- Lower satisfaction with life
The findings for greed are stronger and more consistent than the findings for self-interest.
3
Lecture 1 | Thinking like an economist
Microeconomics
Adam Smith (1776) wrote the important book ‘The wealth of nations’ which has made a field
of Economics.
The rational-economic man makes decisions based on the rational analysis of potential and
desired outcomes and acts in his or her own rational self-interest. Humans are only guided by
our own interest and try to maximize their own outcomes.
The invisible hand is a metaphor for how, in a free market economy, self-interested
individuals operate through a system of mutual interdependence. This interdependence
incentivizes producers to make what is socially necessary, even though they may care only
about their own well-being.
a Everyone only pursues self-interest, but thereby collectively create prosperity.
An example
A business owner, seeking only to make themselves better off, might sell an item of higher
quality and at a lower price than his competitors. Keeping prices low may increase demand
and create competition among other suppliers offering similar products.
“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. But the study of his own advantage naturally, or rather
necessarily leads him to prefer that employment which is most advantageous to the society.”
If every economic actor only thinks about what is best for itself, the economy will be perfect,
and the market will solve potential problems itself.
Carl Menger (1871) published the book ‘Grundsätze der Volkswirtschaftslehre’ in which he
introduced two psychological concepts to the field of economics:
- Utility
A term used to determine the worth or value of a good or service. More specifically, it
is the total satisfaction or benefit derived from consuming a good or service.
Something can have utility for one, but not for the other; it is subjective.
- Motives
Something that causes us to act or behave in order to reach a goal or desired endpoint.
A motive is the reason why you do something.
Menger contributed to the development of the theories of marginalism and marginal utility.
- Marginalism is a theory that asserts individuals make decisions on the purchase of an
additional unit of a good or service based on the additional utility they will receive from
it.
- Marginal utility is the added satisfaction that a consumer gets from having one more
unit of a good or service. This concept is used by economists to determine how much
of an item consumers are willing to purchase.
1
,Menger’s view on life, food, and tobacco:
The columns represent different kinds of
wants, in the order of their importance; the
numbers in any column represent successive
want-satisfactions from unit increases of the
stock of goods satisfying that want-in modern
terms, the "marginal" utilities.
The first five columns may represent food; column V represents tobacco. Ten units of "food"
represent the individual's need for food.
The first thing you are motivated for to require is food. When you are satisfied, you go to
another level; food 2, food 3, and food 4. After satisfied of all levels of food, you go on to the
next level; tobacco 5.
To predict which decisions the rational consumer makes, we have to know something about:
• Preferences | indifference curves
• Income | budget line
• Prices | budget line
Preferences: indifference curves
Properties of an indifference curve:
1. Away from 0 = higher 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).
If you have 1000 CDs and 50 books, you will not
give up many books for 1 CD.
Budget line: income & prices
2
, Utility maximization = the concept that individuals and organizations seek to attain the
highest level of satisfaction from their economic decisions.
The rational economic man:
• Has all the information needed to make a rational choice
• Maximizes utility
• Is self-interested (greed)
• Has stable preferences
• Has no emotions
Greed
Greed = an intense and selfish desire for something (especially wealth, power, or food). It is
about wanting more and more and more.
Greed is correlated with, but different from:
- Maximizing
- Materialism
- Self-interest
Study by Hoyer et al. (2022)
This was a correlational study where greed and self-interest were measured. They found
correlations with:
• Economic outcomes
Personal & household income.
• Evolutionary outcomes
# children, longest relation, # sexual partners.
• Psychological outcomes
Satisfaction with life.
Social value orientation is a person’s preference about how to allocate resources (e.g. money)
between the self and another person. It corresponds to how much weight a person attaches
to the welfare of others in relation to the own.
According to studies:
• Men are more greedy
• Younger people are more greedy
Those who scored high on greed, have:
- A higher household income
But not personal.
- Fewer children
- More sexual partners
Not after controlling for age.
- Shorter relationships
- Lower satisfaction with life
The findings for greed are stronger and more consistent than the findings for self-interest.
3
