Economic Psychology
Table of contents:
lecture 0.0 - The history of economic psychology
Lecture 0.1 - The simple psychology of decision-making
Lecture 1 -Introduction
Paper: The theory of decision-making
Lecture 2 - Prospect theory
Lecture 2.1 - Choice over time
Lecture 2.2 - Mental accounting
Paper: Choices, values and frames
Paper: Mental accounting and consumer choice
Lecture 3 - Reason & emotion-based choice
Lecture 3.1 - Beyond self-interest
Paper: Moral sentiments
Paper: Reason-based choice
Paper: Emotion-based choice
Paper: Beyond self-interest
Paper: Does studying economics inhibit cooperation…?
Paper: Fairness and the assumption of economics
Paper: Generosity pays
Paper: Dispositional greed
Paper: Maximising vs satisficing: Happiness is a matter of choice
Paper: Dishonesty of honest people
Paper: Greedy bastards: Testing the relationship between wanting more and unethical behavior
Paper: Justified ethicality: Observing desired counterfactuals modifies ethical perceptions and behavior
Paper: Experimental economics from the vantagepoint of behavioral economics
Paper: Psychology and economics conference handbook
,Lecture 0.0 - The history of economic psychology
People
● Adam Smith (1776)
○ ‘An inquiry into the nature and causes of the wealth of nations’
○ How countries develop
○ Believed that people were rational economic men
○ When everyone acts on their own self-interest → everyone is cared for
○ When one looks into how to make money
■ driven by self-interest BUT one looks for what others need → useful for society
(many people with many specializations)
● Adam Smith (1759)
○ ‘The theory of moral sentiments’
○ There are principles in the nature of humans that interest them in the advantage of others=
basic moral standards
● Blaise Pascal (1600s)
○ The value of future gain should be directly proportional to the chance of getting it
○ EV=p*x (expected value= probability*gain)
● Jeremy Bentham
○ It is not the monetary but psychological valuethat matters = money → utility
○ Transformation of money into utility
○ Expected utility theory
■ eg. cheap and effective prison reforms
○ Utility = how much pleasure something brings
○ In order to maximize utility, we need to quantify and compare the amount of pleasure of
possible acts
■ hedons- units of pleasure
■ dolors- units of pain
■ decision-making progress = hedonic calculus
● John Stuart Mill
○ Utility/greatest happiness principle
■ good=happiness
■ right actions are those that maximize the total happiness of the members of a
community
■ actions are good in proportion so far as they tend to promote happiness for moral
agents
■ policies governments employ could be evaluated in terms of utility
● Carl Menger
○ Motives and utility
● Clark
○ “Impossible for the economist to avoid human nature”
○ Economic behavior is the product of humans → Psychological insight needed
● Simon
○ Bounded rationality
■ people have cognitive limitations
■ people are rational WITHIN their limits
○ Satisficing= look for something that's good enough
■ not the same as maximizing
○ Study of cognitive processes leading to decisions
● Kahneman
, ○ Prospect theory
○ Risk aversion for losses
● Thaler
○ Mental accounting
○ Behavioral finance
● Edwards
○ Behavioral decision-making
Psychology and Economics
● Drifting apart
○ Psychology → research-, individual-, focused, descriptive & inductive
○ Economics → assumption-, group-focused, normative & deductive (also many deviations
from theories)
● George Katona
○ Bringing Psychology and Economics back together
○ 1975: “Psychological economies”
○ Index of consumer sentiment→ prediction of people whether the economy is going
up/down
○ Need to discover and analyzeforces behind economic processes, decisions and choices
Mind map
, Lecture 0.1 - The simple psychology of decision-making
● Rationality
○ Look at what a decision can give and the probability of that outcome → expected value
○ Goal: maximization of expected value
● Expected value
○ 1700s - Pascal, Fermat & Huygens
○ EV = p * x
Cognitive heuristic
Cognitive shortcutsto arrive at probability estimations (may lead to systematic errors)
● Availability heuristic
○ Assessing the probability of an event by the ease with which instances can be brought to
mind
○ eg. How many words come to mind when
■ R_ _ _ _ _
■ _ _ R_ _ _
○ Things that happen often do not get as much attention anymore
■ eg. death by guns versus diabetes
■ eg. the lights and noises in casinos make people overestimate the chances of winning
● Representativeness heuristic
○ If someone seems to be representative of a type, we assume they belong there despite the
probabilities
Bernoulli
● The determination of a value of an item must not be based on the price but on the utility it yields
● Expected utility theory
● EV≠EU
Expected utility
● Subjective value of outcome
● Marginal decreasein utility → less and less
added pleasure after obtaining a number of items
● In simple economics 2 factors determine what
people do
○ Pleasurepeople get from doing
something
○ Priceof doing/consuming
The problem of value
● How can pleasure be measured?
● Bentham → conceptualize utility as balance in pain & pleasure
● Mathematical theories in economics are based on the idea that utility is a real psychological entity
Table of contents:
lecture 0.0 - The history of economic psychology
Lecture 0.1 - The simple psychology of decision-making
Lecture 1 -Introduction
Paper: The theory of decision-making
Lecture 2 - Prospect theory
Lecture 2.1 - Choice over time
Lecture 2.2 - Mental accounting
Paper: Choices, values and frames
Paper: Mental accounting and consumer choice
Lecture 3 - Reason & emotion-based choice
Lecture 3.1 - Beyond self-interest
Paper: Moral sentiments
Paper: Reason-based choice
Paper: Emotion-based choice
Paper: Beyond self-interest
Paper: Does studying economics inhibit cooperation…?
Paper: Fairness and the assumption of economics
Paper: Generosity pays
Paper: Dispositional greed
Paper: Maximising vs satisficing: Happiness is a matter of choice
Paper: Dishonesty of honest people
Paper: Greedy bastards: Testing the relationship between wanting more and unethical behavior
Paper: Justified ethicality: Observing desired counterfactuals modifies ethical perceptions and behavior
Paper: Experimental economics from the vantagepoint of behavioral economics
Paper: Psychology and economics conference handbook
,Lecture 0.0 - The history of economic psychology
People
● Adam Smith (1776)
○ ‘An inquiry into the nature and causes of the wealth of nations’
○ How countries develop
○ Believed that people were rational economic men
○ When everyone acts on their own self-interest → everyone is cared for
○ When one looks into how to make money
■ driven by self-interest BUT one looks for what others need → useful for society
(many people with many specializations)
● Adam Smith (1759)
○ ‘The theory of moral sentiments’
○ There are principles in the nature of humans that interest them in the advantage of others=
basic moral standards
● Blaise Pascal (1600s)
○ The value of future gain should be directly proportional to the chance of getting it
○ EV=p*x (expected value= probability*gain)
● Jeremy Bentham
○ It is not the monetary but psychological valuethat matters = money → utility
○ Transformation of money into utility
○ Expected utility theory
■ eg. cheap and effective prison reforms
○ Utility = how much pleasure something brings
○ In order to maximize utility, we need to quantify and compare the amount of pleasure of
possible acts
■ hedons- units of pleasure
■ dolors- units of pain
■ decision-making progress = hedonic calculus
● John Stuart Mill
○ Utility/greatest happiness principle
■ good=happiness
■ right actions are those that maximize the total happiness of the members of a
community
■ actions are good in proportion so far as they tend to promote happiness for moral
agents
■ policies governments employ could be evaluated in terms of utility
● Carl Menger
○ Motives and utility
● Clark
○ “Impossible for the economist to avoid human nature”
○ Economic behavior is the product of humans → Psychological insight needed
● Simon
○ Bounded rationality
■ people have cognitive limitations
■ people are rational WITHIN their limits
○ Satisficing= look for something that's good enough
■ not the same as maximizing
○ Study of cognitive processes leading to decisions
● Kahneman
, ○ Prospect theory
○ Risk aversion for losses
● Thaler
○ Mental accounting
○ Behavioral finance
● Edwards
○ Behavioral decision-making
Psychology and Economics
● Drifting apart
○ Psychology → research-, individual-, focused, descriptive & inductive
○ Economics → assumption-, group-focused, normative & deductive (also many deviations
from theories)
● George Katona
○ Bringing Psychology and Economics back together
○ 1975: “Psychological economies”
○ Index of consumer sentiment→ prediction of people whether the economy is going
up/down
○ Need to discover and analyzeforces behind economic processes, decisions and choices
Mind map
, Lecture 0.1 - The simple psychology of decision-making
● Rationality
○ Look at what a decision can give and the probability of that outcome → expected value
○ Goal: maximization of expected value
● Expected value
○ 1700s - Pascal, Fermat & Huygens
○ EV = p * x
Cognitive heuristic
Cognitive shortcutsto arrive at probability estimations (may lead to systematic errors)
● Availability heuristic
○ Assessing the probability of an event by the ease with which instances can be brought to
mind
○ eg. How many words come to mind when
■ R_ _ _ _ _
■ _ _ R_ _ _
○ Things that happen often do not get as much attention anymore
■ eg. death by guns versus diabetes
■ eg. the lights and noises in casinos make people overestimate the chances of winning
● Representativeness heuristic
○ If someone seems to be representative of a type, we assume they belong there despite the
probabilities
Bernoulli
● The determination of a value of an item must not be based on the price but on the utility it yields
● Expected utility theory
● EV≠EU
Expected utility
● Subjective value of outcome
● Marginal decreasein utility → less and less
added pleasure after obtaining a number of items
● In simple economics 2 factors determine what
people do
○ Pleasurepeople get from doing
something
○ Priceof doing/consuming
The problem of value
● How can pleasure be measured?
● Bentham → conceptualize utility as balance in pain & pleasure
● Mathematical theories in economics are based on the idea that utility is a real psychological entity
