Behavioral economics is the study of the psychological, cognitive, emotional, cultural and social factors involved in the decisions of individuals or institutions, and how these decisions deviate from those implied by classical economic theory.^[1][2]

Behavioral economics is primarily concerned with the bounds of rationality of economic agents. Behavioral models typically integrate insights from psychology, neuroscience and microeconomic theory.^[3][4] The study of behavioral economics includes how market decisions are made and the mechanisms that drive public opinion.

Behavioral economics began as a distinct field of study in the 1970s and '80s, but can be traced back to 18th-century economists, such as Adam Smith, who deliberated how the economic behavior of individuals could be influenced by their desires.^[5]

The status of behavioral economics as a subfield of economics is a fairly recent development; the breakthroughs that laid the foundation for it were published through the last three decades of the 20th century.^[6][7] Behavioral economics is still growing as a field, being used increasingly in research and in teaching.^[8]

History

Early classical economists included psychological reasoning in much of their writing, though psychology at the time was not a recognized field of study.^[9] In The Theory of Moral Sentiments, Adam Smith wrote on concepts later popularized by modern Behavioral Economic theory, such as loss aversion.^[9] Jeremy Bentham, a Utilitarian philosopher in the 1700s conceptualized utility as a product of psychology.^[9] Other economists who incorporated psychological explanations in their works included Francis Edgeworth, Vilfredo Pareto and Irving Fisher.

A rejection and elimination of psychology from economics in the early 1900s brought on a period defined by a reliance on empiricism.^[9] There was a lack of confidence in hedonic theories, which saw pursuance of maximum benefit as an essential aspect in understanding human economic behavior.^[6] Hedonic analysis had shown little success in predicting human behavior, leading many to question its viability as a reliable source for prediction.^[6]

There was also a fear among economists that the involvement of psychology in shaping economic models was inordinate and a departure from accepted principles.^[10] They feared that an increased emphasis on psychology would undermine the mathematic components of the field.^[11][12]

To boost the ability of economics to predict accurately, economists started looking to tangible phenomena rather than theories based on human psychology.^[6] Psychology was seen as unreliable to many of these economists as it was a new field, not regarded as sufficiently scientific.^[9] Though a number of scholars expressed concern towards the positivism within economics, models of study dependent on psychological insights became rare.^[9] Economists instead conceptualized humans as purely rational and self-interested decision makers, illustrated in the concept of homo economicus.^[12]

The resurgence of psychology within economics, which facilitated the expansion of behavioral economics, has been linked to the cognitive revolution.^[13][14] In the 1960s, cognitive psychology began to shed more light on the brain as an information processing device (in contrast to behaviorist models). Psychologists in this field, such as Ward Edwards,^[15] Amos Tversky and Daniel Kahneman began to compare their cognitive models of decision-making under risk and uncertainty to economic models of rational behavior. These developments spurred economists to reconsider how psychology could be applied to economic models and theories.^[9] Concurrently, the Expected utility hypothesis and discounted utility models began to gain acceptance. In challenging the accuracy of generic utility, these concepts established a practice foundational in behavioral economics: Building on standard models by applying psychological knowledge.^[6]

Mathematical psychology reflects a longstanding interest in preference transitivity and the measurement of utility.^[16]

Development of Behavioral Economics

In 2017, Niels Geiger, a lecturer in economics at the University of Hohenheim conducted an investigation into the proliferation of behavioral economics.^[8] Geiger's research looked at studies that had quantified the frequency of references to terms specific to behavioral economics, and how often influential papers in behavioral economics were cited in journals on economics.^[8] The quantitative study found that there was a significant spread in behavioral economics after Kahneman and Tversky's work in the 1990s and into the 2000s.^[8]