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Kahneman and Tversky and the Origin of Behavioral Economics

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  • Floris Heukelom

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    (ASE, Universiteit van Amsterdam)

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    Abstract

    Kahneman and Tversky and their behavioral economics stand in a long tradition of applying mathematics to human behavior. In the seventeenth century, attempts to describe rational behavior in mathematical terms run into problems with the formulation of the St. Petersburg paradox. Bernoulli’s celebrated solution to use utility instead of money marks the beginning of expected utility theory (EUT). Bernoulli’s work is taken up by psychophysics which in turn plays an important role in the making of modern economics. In the 1940s von Neumann and Morgenstern throw away Bernoulli and psychophysics, and redefine utility in monetary terms. Relying on this utility definition and on von Neumann and Morgenstern’s axiomatic constraints of the individual’s preferences, Friedman and Savage attempt to continue Bernoulli’s research. After this fails economics and psychology go separate ways. Economics employs Friedman’s positive-normative distinction; psychology uses Savage’s normative-descriptive distinction. Using psychophysics Kahneman and Tversky broaden the normative-descriptive distinction and argue with increasing strength for a descriptive theory of rational behavior. A prominent part of contemporary behavioral economics is founded upon the export of Tversky and Kahneman’s program to economics. Within this research, two different branches of research can be observed. One branch continues Kahneman and Tversky’s search for a descriptive theory of rational behavior and extends the normative-descriptive distinction with a prescriptive part. A second branch takes Tversky and Kahneman’s work as a falsification of positive economics. It argues that economics should take account of the psychological critique but stick to rigorous mathematical model building and Friedman’s positive-normative distinction.

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    Bibliographic Info

    Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 07-003/1.

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    Date of creation: 11 Jan 2007
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    Handle: RePEc:dgr:uvatin:20070003

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    Keywords: Kahneman and Tversky; behavioral economics; expected utility theory; normative economics;

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    1. Matthew Rabin., 1997. "Psychology and Economics," Economics Working Papers, University of California at Berkeley 97-251, University of California at Berkeley.
    2. Wakker, P.P. & Thaler, R.H. & Tversky, A., 1997. "Probabilistic insurance," Discussion Paper, Tilburg University, Center for Economic Research 1997-35, Tilburg University, Center for Economic Research.
    3. Kahneman, Daniel & Thaler, Richard H, 1991. "Economic Analysis and the Psychology of Utility: Applications to Compensation Policy," American Economic Review, American Economic Association, American Economic Association, vol. 81(2), pages 341-46, May.
    4. Tversky, Amos & Wakker, Peter, 1995. "Risk Attitudes and Decision Weights," Econometrica, Econometric Society, Econometric Society, vol. 63(6), pages 1255-80, November.
    5. Fox, Craig R & Tversky, Amos, 1995. "Ambiguity Aversion and Comparative Ignorance," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 110(3), pages 585-603, August.
    6. Milton Friedman & L. J. Savage, 1952. "The Expected-Utility Hypothesis and the Measurability of Utility," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 60, pages 463.
    7. Ted O'Donoghue & Matthew Rabin, 1996. "Doing It Now or Later," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 1172, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    8. Sophie Jallais & Pierre-Charles Pradier & David Teira, 2008. "Facts, Norms and Expected Utility Functions," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-00274361, HAL.
    9. Loewenstein, George, 1999. "Experimental Economics from the Vantage-Point of Behavioural Economics," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 109(453), pages F23-34, February.
    10. Tversky, Amos & Kahneman, Daniel, 1992. " Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, Springer, vol. 5(4), pages 297-323, October.
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    Cited by:
    1. Oscar Lara Murillo, 2012. "Framing en las decisiones de inversión de Brokers financieros de Veracruz," Revista Observatorio Calasanz, Universidad Cristobal Colon, Dpto. de Investigacion y Posgrado, Universidad Cristobal Colon, Dpto. de Investigacion y Posgrado, vol. 3(6), pages pp.352-361, Febrero.
    2. Berg, Nathan, 2010. "Behavioral Economics," MPRA Paper 26587, University Library of Munich, Germany.

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