Classical economic theory assumes people act rationally and strive to maximise their gains. Yet a strand of scholarship disputes this, pointing out that people often act irrationally, swayed by emotions, biases and cognitive limits.<\/p>\n
In this ForkLog article, we examine how behavioural economics has changed the way we think about human action, why it became influential, and the challenges it has encountered.<\/p>\n
For a long time, economic theory rested on the assumption that people act rationally, weighing every decision and assessing benefits. In classical models, the value of a good depends on how much of it a person has: the first unit is highly desired, the second less so, and subsequent ones barely matter.<\/p>\n
Armed with such ideas and mathematical methods, scholars sought to explain how the economy works. This approach, known as the \u2018economic man\u2019 concept<\/a>, underpinned much research. In practice, however, people often behave otherwise. Behavioural economics emerged to account for these deviations, showing that decisions are frequently shaped by incidental, independent factors such as emotions, social pressure and cognitive biases.<\/p>\n Psychological aspects of behaviour were addressed as early as Adam Smith\u2019s \u201cThe Theory of Moral Sentiments<\/a>\u201d (1759). In the 20th century, cognitive psychology developed and showed that departures from rationality are systematic and predictable. Behavioural economics took clearer shape as a bridge between individual behaviour and economic processes, offering a new perspective on markets, investment and public policy.<\/p>\n One of the field\u2019s key contributions is the idea of bounded rationality, developed by the American scholar Herbert Simon. He showed that people rarely have all the information and cognitive resources needed to make ideal decisions. Instead they rely on simplified rules that help them navigate complexity more quickly. His ideas laid the groundwork for analysing real human behaviour and for further research in behavioural economics.<\/p>\n In 1979, psychologists Daniel Kahneman and Amos Tversky published Prospect Theory: An Analysis of Decision under Risk<\/a>, which founded prospect theory. It describes how people choose between alternatives with known outcome probabilities. Individuals evaluate gains and losses relative to a reference point, overweighting low-probability events and underweighting high-probability ones.<\/p>\n Kahneman and Tversky showed that losses loom larger than equivalent gains: losing $100 hurts more than gaining $100 pleases. Choices also depend on framing \u2014 the way information is presented. For example, people are more likely to opt for an operation with a \u201c90% success rate\u201d than one with a \u201c10% risk\u201d, though both are identical. Prospect theory reshaped notions of rationality and became a cornerstone of behavioural economics.<\/p>\n The American economist Richard Thaler \u2014 one of the field\u2019s leading popularisers \u2014 made major contributions by showing how small changes in the environment can strongly influence behaviour. His \u201cnudge\u201d concept posits that well-designed prompts \u2014 for example, automatic enrolment in a pension programme or putting healthy food at eye level in a canteen \u2014 can steer people towards better choices without infringing their freedom to choose.<\/p>\n Thaler also studied bounded rationality, social preferences and self-control, stressing that people often act against their long-term interests. In 2017 he received the Nobel prize and joked that he would spend the prize money \u201cas irrationally as possible\u201d, neatly illustrating the human nature he had studied for decades.<\/p>\n Another important strand applies behavioural principles to financial markets, where irrationality is especially vivid. The 2013 Nobel laureate Robert Shiller showed how psychological factors such as over-optimism or panic foster bubbles and crises. His analysis of the late-1990s dotcom bubble and the 2008 mortgage crisis demonstrated that markets are far from always efficient. Shiller highlighted the role of \u201cnarrative economics\u201d \u2014 stories and expectations that shape investor behaviour and generate waves of hype or fear.<\/p>\n From a behavioural-economics perspective, human decisions often diverge from rational models because of psychological, emotional and social factors. These deviations are not random but systematic and predictable, allowing their impact on economic behaviour to be analysed.<\/p>\n The field rests on several key ideas that explain why people act irrationally and how this shows up in everyday choices, from shopping to investing:<\/p>\n Behavioural economics drew inspiration from psychology but applied its principles to economic processes, analysing how irrationality influences markets, policy and individual decisions.<\/p>\n Heuristics are simplified mental strategies used to make quick decisions under uncertainty, relying on experience or intuition. They can, however, produce cognitive biases by oversimplifying complex information, ignoring important details or overweighting particular factors \u2014 and thus lead to error.<\/p>\n There are many heuristics and biases, and researchers keep identifying new ones. Here are a few:<\/p>\n Building on these features of thought, behavioural economics shows that economic behaviour is not just about calculating payoffs; it is a complex interplay of psychology, emotions and social norms.<\/p>\n Behavioural economics has not escaped criticism, often from adherents of traditional theory. Scholars such as Milton Friedman, Gary Becker and Eugene Fama argue that in competitive settings with access to knowledge people, while not perfect, gravitate towards rational behaviour.<\/p>\n Friedman stressed that economic models need not describe behaviour perfectly if they predict market outcomes successfully. Fama, known for the efficient-market hypothesis, argued that the anomalies flagged by behavioural economists often have rational explanations or stem from limited data rather than systematic irrationality. In this view, real markets \u2014 with their dynamics and learning \u2014 push people towards near-optimal choices, making lab-based findings less applicable to complex situations.<\/p>\n Sceptics also target the field\u2019s methods. Experiments and surveys, on which much of the research relies, are prone to systematic distortions. Respondents may display bias or act strategically, and their answers may not reflect true preferences.<\/p>\n Traditional economics emphasises revealed preferences \u2014 those manifested in actual behaviour \u2014 rather than stated ones. David K. Levine, in Is Behavioral Economics Doomed?<\/a> (2012), highlights the problem of weak incentives for experimental subjects, which can undermine validity. He also criticises the field for a tendency to craft a new theory for each new fact instead of seeking a unified explanatory model.<\/p>\n Another contentious issue is ethics. The psychologist Nick Chater expressed concern<\/a> that Thaler\u2019s \u201cnudge\u201d could be seen as a call to manipulation, especially if people are unaware their choices are being steered. This reflects a dilemma between free will and attempts to improve decisions via psychological mechanisms. Despite its successes, behavioural economics remains a field of sharp debate about human nature and how to study it.<\/p>\n Behavioural economics is evolving fast, integrating with other disciplines such as neuroeconomics (the study of the brain during decision-making), behavioural finance<\/a> and big-data analysis. The use of artificial intelligence makes it possible to study behaviour in real time and build more accurate models.<\/p>\nIrrationality at work: how we err<\/h2>\n
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Heuristics: traps of the mind<\/h2>\n
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Nudge or manipulation? Ethics and debates<\/h2>\n
An economy with a human face: what next?<\/h2>\n