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Psychology and Economics

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  • Rabin, Matthew

Abstract

Because psychology systematically explores human judgment, behavior, and well-being, it can teach us important facts about how humans differ from traditional economic assumptions. In this essay I discuss a selection of psychological findings relevant to economics. Standard economics assumes that each person has stable, well-defined preferences, and that she rationally maximizes those preferences. Section 2 considers what psychological research teaches us about the true form of preferences, allowing us to make economics more realistic within the rational-choice framework. Section 3 reviews research on biases in judgment under uncertainty; because those biases lead people to make systematic errors in their attempts to maximize their preferences, thi s research poses a more radical challenge to the economics model. The array of psychological findings reviewed in Section 4 points to an even more radical critique of the economics model: Even if we are willing to modify our familiar assumptions about p references, or allow that people make systematic errors in their attempts to maximize those preferences, it is sometimes misleading to conceptualize people as attempting to maximize well-defined coherent, or stable preferences.

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Bibliographic Info

Paper provided by Department of Economics, Institute for Business and Economic Research, UC Berkeley in its series Department of Economics, Working Paper Series with number qt8jd5z5j2.

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Date of creation: 01 Jan 1997
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Handle: RePEc:cdl:econwp:qt8jd5z5j2

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Keywords: bounded rationality; decision making; fairness; framing effects; heuristics and biases; preferences; psychology; reciprocity; reference-dependent utility; Social and Behavioral Sciences;

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