Behavioral Economics is the combination of psychology and economics that investigates what happens in markets in which some of the agents display human limitations and complications. We begin with a preliminary question about relevance. Does some combination of market forces, learning and evolution render these human qualities irrelevant? No. Because of limits of arbitrage less than perfect agents survive and influence market outcomes. We then discuss three important ways in which humans deviate from the standard economic model. Bounded rationality reflects the limited cognitive abilities that constrain human problem solving. Bounded willpower captures the fact that people sometimes make choices that are not in their long-run interest. Bounded self-interest incorporates the comforting fact that humans are often willing to sacrifice their own interests to help others. We then illustrate how these concepts can be applied in two settings: finance and savings. Financial markets have greater arbitrage opportunities than other markets, so behavioral factors might be thought to be less important here, but we show that even here the limits of arbitrage create anomalies that the psychology of decision making helps explain. Since saving for retirement requires both complex calculations and willpower, behavioral factors are essential elements of any complete descriptive theory.
|Date of creation:||Oct 2000|
|Date of revision:|
|Publication status:||published as International Encyclopedia of SocialSciences, Pergamon Press, 1st edition, October 1, 2001: 1094-1100.|
|Contact details of provider:|| Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.|
Web page: http://www.nber.org
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Russell, Thomas & Thaler, Richard, 1985. "The Relevance of Quasi Rationality in Competitive Markets," American Economic Review, American Economic Association, vol. 75(5), pages 1071-82, December.
- Shefrin, Hersh & Statman, Meir, 1985. " The Disposition to Sell Winners Too Early and Ride Losers Too Long: Theory and Evidence," Journal of Finance, American Finance Association, vol. 40(3), pages 777-90, July.
- De Long, J Bradford & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1990.
"Noise Trader Risk in Financial Markets,"
Journal of Political Economy,
University of Chicago Press, vol. 98(4), pages 703-38, August.
- De Long, J. Bradford & Shleifer, Andrei & Summers, Lawrence H. & Waldmann, Robert J., 1990. "Noise Trader Risk in Financial Markets," Scholarly Articles 3725552, Harvard University Department of Economics.
- J. Bradford De Long & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, . "Noise Trader Risk in Financial Markets," J. Bradford De Long's Working Papers _124, University of California at Berkeley, Economics Department.
- De Bondt, Werner F M & Thaler, Richard, 1985. " Does the Stock Market Overreact?," Journal of Finance, American Finance Association, vol. 40(3), pages 793-805, July.
- Colin Camerer & Linda Babcock & George Loewenstein & Richard Thaler, 1997. "Labor Supply of New York City Cabdrivers: One Day at a Time," The Quarterly Journal of Economics, Oxford University Press, vol. 112(2), pages 407-441.
- Haltiwanger, John & Waldman, Michael, 1985.
"Rational Expectations and the Limits of Rationality: An Analysis of Heterogeneity,"
American Economic Review,
American Economic Association, vol. 75(3), pages 326-40, June.
- John Haltiwanger & Michael Waldman, 1983. "Rational Expectations and the Limits of Rationality: An Analysis of Heterogeneity," UCLA Economics Working Papers 303, UCLA Department of Economics.
- Charles Lee & Andrei Shleifer & Richard Thaler, 1990.
"Investor Sentiment and the Closed-End Fund Puzzle,"
NBER Working Papers
3465, National Bureau of Economic Research, Inc.
- Shleifer, Andrei & Vishny, Robert W, 1997.
" The Limits of Arbitrage,"
Journal of Finance,
American Finance Association, vol. 52(1), pages 35-55, March.
- Andrei Shleifer ad Robert W. Vishny, 1995. "The Limits of Arbitrage," Harvard Institute of Economic Research Working Papers 1725, Harvard - Institute of Economic Research.
- Andrei Shleifer & Robert W. Vishny, 1995. "The Limits of Arbitrage," NBER Working Papers 5167, National Bureau of Economic Research, Inc.
- Kenneth A. Froot & Emil Dabora, 1998.
"How are Stock Prices Affected by the Location of Trade?,"
NBER Working Papers
6572, National Bureau of Economic Research, Inc.
- Froot, Kenneth A. & Dabora, Emil M., 1999. "How are stock prices affected by the location of trade?," Journal of Financial Economics, Elsevier, vol. 53(2), pages 189-216, August.
- Banks, James & Blundell, Richard & Tanner, Sarah, 1998.
"Is There a Retirement-Savings Puzzle?,"
American Economic Review,
American Economic Association, vol. 88(4), pages 769-88, September.
- Richard Thaler, 1985.
"Mental Accounting and Consumer Choice,"
INFORMS, vol. 4(3), pages 199-214.
- John Conlisk, 1996. "Why Bounded Rationality?," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 669-700, June.
When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:7948. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()
If references are entirely missing, you can add them using this form.