Question

Identify each statement as being associated with neoclassical economics or behavioral economics. a. People are eager and accurate calculators. b. People are often selfless and generous. c. People have no trouble resisting temptation. d. People place insufficient weight on future events and outcomes. e. People only treat others well if doing so will get them something they want.

Short answer

Statements a, c, and e are neoclassical economics; statements b and d are behavioral economics.

Step-by-step solution

Analyzing Statement A

Neoclassical economics assumes that people are rational and make decisions using all available information to maximize utility. The statement "People are eager and accurate calculators" aligns with this view. Therefore, this statement is associated with neoclassical economics.

Analyzing Statement B

Behavioral economics recognizes that people often act based on emotions, social influences, and cognitive biases, leading them to act selfless or generous. The statement "People are often selfless and generous" fits within the behavioral economics perspective. Hence, it is associated with behavioral economics.

Analyzing Statement C

In neoclassical economics, individuals are assumed to have perfect self-control and do not give in to temptations. The statement "People have no trouble resisting temptation" aligns with the assumptions made in neoclassical economics, although it's often countered by behavioral economics findings.

Analyzing Statement D

Behavioral economics suggests that people often exhibit present bias, where they place excessive importance on immediate rewards over future benefits. The statement "People place insufficient weight on future events and outcomes" describes this behavior, making it associated with behavioral economics.

Analyzing Statement E

Neoclassical economics assumes individuals act in ways to maximize personal gain. The statement "People only treat others well if doing so will get them something they want" reflects a view where actions are calculated for personal benefit, characteristic of neoclassical economics.

Key concepts

Neoclassical Economics

Neoclassical economics is a traditional economic theory that emerged in the late 19th century. It focuses on the idea that people are rational and make decisions to maximize their utility, or overall satisfaction. Key assumptions include:

• Rationality: Individuals make choices based on available information and aim to optimize their preferences.
• Utility Maximization: People weigh costs and benefits to make decisions that confer the greatest personal benefit.
• Market Equilibrium: Markets are assumed to naturally move towards equilibrium where supply equals demand.

The central concept here is the belief in human rationality, meaning that individuals are seen as logical entities with an innate ability to evaluate the best course of action. In this way, neoclassical economics views humans as systematic calculators who evaluate every decision meticulously, making choices solely based on personal gain. This assumption is quite theoretical and assumes individuals have perfect information and cognitive capacity to process it.

Rationality

Rationality is a cornerstone of economic theory, especially in the context of neoclassical economics. It proposes that individuals always choose the most logical and economical option based on their preferences and available information. There are two primary types of rationality:

• Instrumental Rationality: This involves selecting the best means to achieve a specific end. Here, individuals choose actions that help them achieve their goals most efficiently.
• Bounded Rationality: Proposed by Herbert Simon, this concept acknowledges human limitations. People aim to be rational but are restricted by cognitive limitations and incomplete information.

In neoclassical models, rationality implies that individuals have access to all necessary information and can process it instantly to make optimal decisions. However, in real-world scenarios, people often face limits in their ability to process complex information, leading to less-than-perfect decision-making.

Utility Maximization

Utility maximization refers to the idea that individuals make choices by comparing the utility or satisfaction they expect to gain from different options. It is a major principle in neoclassical economics, suggesting that people are driven to achieve the highest level of happiness or satisfaction possible. Here's how it works:

• Choice Evaluation: People consider the utility from each possible option and evaluate which provides the highest utility.
• Marginal Utility: This involves looking at the additional satisfaction gained from consuming an additional unit of a good or service and how it decreases as more is consumed, known as diminishing marginal utility.
• Budget Constraint: Individuals make choices constrained by their incomes and prices of goods, aiming to maximize utility within these limits.

The assumption of utility maximization assumes rational behavior, suggesting individuals precisely evaluate each decision. However, this does not account for the complexity of human emotions and influences that may lead people to make irrational choices.

Cognitive Biases

Cognitive biases are systematic patterns of deviation from norm or rationality in judgment. Behavioral economics often studies these biases to illustrate how humans deviate from rational decision-making. Some common cognitive biases include:

• Present Bias: The tendency to overvalue immediate rewards at the expense of long-term intentions.
• Overconfidence Bias: When individuals have excessive confidence in their own answers or abilities.
• Anchoring: The reliance on the first piece of information encountered (the "anchor") when making decisions.
• Confirmation Bias: The tendency to search for, interpret, and recall information that confirms one's preexisting beliefs.

These biases challenge the notion of human rationality proposed by neoclassical economics. They highlight the many ways in which human thinking can go awry, leading to choices that are not necessarily optimal or logical. Acknowledging cognitive biases allows us to understand the complexities of human decision-making rather than solely viewing individuals as rational calculators.