Behavioural economics, the future of economic models?

#1

Many often in all of our economics models we make the assumption that all individuals are rational and that any factor that cannot be explained is simply an exogenous variable. Although this simplifies many complicated behaviours and situations that are hard to model.

The reality is that many times models such as the DSGE model fail to take into account these human factors and often times oversimplify results. For instance, any factor that is not accounted in the model is taken as an exogenous variable and the individual re-adjusts their maximization problem to consider this new variable (maybe a change in the budget constraint). Nothing within the model creates an endogenous effect, any disturbance is simply attributed to an exogenous factor.

This is why I think it is very interesting to take into account the “behavioural aspect of economics”. By embracing such factors we are not just analyzing how individuals react to exogenous “shocks” but instead we are taking into account that those “shocks” are simply a result of economic behaviours and are not isolated events.

In models such as the Walrasian Model, it´s very simple to think of it as a few individuals trading their endowments and not much else. We analyze the case where something happens to the endowment and how it affects the new equilibrium. However, we never take into account that maybe the original equilibrium influenced the individual´s decisions and thus leading us to a new equilibrium without it coming from an outside “shock”.

Without a doubt over the last 10 years the behavioural economics field has developed more and more. This could be because we´ve finally come to realize that our models fail to predict behaviours because we tend to fall into assumptions about rationality, when in reality individuals not always act in the most rational ways.

I´d like to hear your opinions on this since it means that we have to add more complexity to the models we´ve studied for years. Is the cost of adding complexity worth it in order to have more precise models?

P. De Grauwe. (2017, November 06). Why behavioural economics could dictate the future of the discipline. Retrieved February 18, 2018, from https://www.weforum.org/agenda/2017/11/this-is-the-value-of-behavioural-economics-in-understanding-our-world/

#2

Hi Karla.
I agree with your opinion that many times economic models leave out some aspects of human behavior. However, as you mentioned, I think it has been a good way to simplify behaviors that are to difficult to model. However, I consider that the point is not to add more complexity to the models but to rethink some assumptions and from that to try to obtain results that are more attached to human behavior.
A clear example is the work done by Manzini and Mariotti in which a contrast of empirical evidence with economic theory is made with respect to cyclical choices and from this they formulate a model in which they include the anomalies contained in the classical model and they obtain a model in which human behavior has a greater importance.

#3

I too think that we should take more behavioural models into consideration in the whole of Economics as a field. As you cite the Walrasian model with endowments, there is actually literature on the subject. Known as the “Endowment effect” individuals tend to value more a good which they own than the same good if they don’t. These leads to different buy and sell prices from the same individual for the same good! So much for rational expectations.
Kahneman, D., Knetsch, J., & Thaler, R. (1991). Anomalies: The endowment effect, loss aversion, and status quo bias. Journal of Economic Perspectives, 5(1), 193-206.

In the end, this new models will not be worked out by the current economists but the upcoming generations will be developing the greatest developments. It is refreshing that these ideas are entering the mainstream after some of its biggest proponents have started receiving the Nobel: Daniel Kanheman, Robert Shiller and Richard Thaler.

btw: For those interested in Behavioural Economics, “Thinking, Fast and Slow” by Kanheman and Tversky is a great gateway.