Behavioral economics

In neoclassical economic theory, it is assumed that decision makers, given their knowledge of utilities, alternatives, and outcomes, can compute which alternative will yield the greatest subjective (expected) utility. The term bounded rationality is used to designate models of rational choice that take into account the cognitive limitations of both knowledge and cognitive capacity. Bounded rationality is a central theme in behavioral economics. It is concerned with the ways in which the actual decision-making process influences the decisions that are eventually reached. To this end, behavioral economics departs from one or more of the neoclassical assumptions underlying the theory of rational behavior. The two most important questions that can be posed are:

  • Are the assumptions of utility or profit maximization good approximations of real behavior?
  • Do individuals maximize subjective expected utility?

    Simon (1987b) provides an overview of the literature on these issues.

    Research in behavioral economics has adopted specific methodological approaches that complement traditional statistical and econometric tests of economic models. For example, experiments are commonly used in behavioral economics, and survey data are also becoming more important in the process of learning about individuals' actual decision-making processes.

    See also: behavioral finance, bounded rationality, models of microeconomic decisions, rational (economic) behavior

    Literature: Kahnemann, Slovic & Tversky (1982), Simon (1987a), Simon (1987b)

    Entry by: Joachim Winter

    June 17, 1999
    Direct questions and comments to: Glossary master