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Integrating Psychology with Economics: Chicago Booth Richard H. Thaler Delivers Nobel Prize Lecture in Sweden

“Richard H. Thaler has incorporated psychologically realistic assumptions into analyses of economic decision-making. By exploring the consequences of limited rationality, social preferences, and lack of self-control, he has shown how these human traits systematically affect individual decisions as well as market outcomes.”

Until Richard Thaler came along, economists resisted the idea of basing their models on how real people behave. The reality is people don’t always know what they want, much less what’s best for them. In October, Thaler received Svergies Riksbank Prize in Economic Sciences in Memory of Alfred Nobel for his pioneering scholarship in the field of behavioral economics. On Dec. 8, the Chicago Booth scholar delivered his Nobel lecture in Stockholm as part of a week-long celebration of the 2017 Nobel Laureates. He received his Nobel Medal on Dec. 10 at a white-tie-and-tails affair at the Stockholm Concert Hall. (Click here to watch).

In the speech, “From Cashews to Nudges: The Evolution of Behavioral Economics,” Thaler’s tells the stories of various field experiments in his everyday life from a dinner party as a graduate student in Rochester, NY, in the 1970s to the Swedish government’s effort today to get its citizens to sign up for retirement plans.

“One lesson from these stories is that there are a bunch of things economic theory says we can leave out and in fact makes the strong prediction that they simply will not matter,” Thaler said. “I call these ‘supposedly irrelevant factors.’ And really my research can be summarized as there are a lot of these supposedly irrelevant factors that are not irrelevant. They matter.”

Thaler launched his journey as one of the founders of behavioral economics with a bowl of cashews at a dinner party. He was concerned his guests were eating too many and that it would spoil their appetites, so he took them away. His guests, all economists, were happy when he removed the nuts, and that led to a discussion: how could they be happy Ð as a first principle of economics is more choices are better than fewer choices.

He also recounted how he and Harvard legal scholar Cass R. Sunstein, coauthors of the bestselling book Nudge, discovered that a simple “nudge” is an effective way to influence choices without forcing anyone to do anything. The findings changed the way many companies set up employee retirement plans, for example automatically enrolling workers in a retirement plan and forcing workers to “opt out” if they don’t want the plan.

“If we learn from other social scientists, we can improve economics and increase its explanatory power and it can give us new tools we can use to improve people’s outcomes,” Thaler said. “In short, we can nudge them.”

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“If we learn from other social scientists, we can improve economics and increase its explanatory power, and it can give us new tools we can use to improve people’s outcome. In short, we can nudge them.”Prof. Richard H. Thaler

Integrating Psychology with Economics

Limited rationality: Thaler developed the theory of mental accounting, explaining how people simplify financial decision-making by creating separate accounts in their minds, focusing on the narrow impact of each individual decision rather than its overall effect. He also showed how aversion to losses can explain why people value the same item more highly when they own it than when they don’t, a phenomenon called the endowment effect. Thaler was one of the founders of the field of behavioural finance, which studies how cognitive limitations influence financial markets.

Social preferences: Thaler’s theoretical and experimental research on fairness has been influential. He showed how consumers’ fairness concerns may stop firms from raising prices in periods of high demand, but not in times of rising costs. Thaler and his colleagues devised the dictator game, an experimental tool that has been used in numerous studies to measure attitudes to fairness in different groups of people around the world.

Lack of self-control: Thaler has also shed new light on the old observation that New Year’s resolutions can be hard to keep. He showed how to analyse self-control problems using a planner-doer model, which is similar to the frameworks psychologists and neuroscientists now use to describe the internal tension between long-term planning and short-term doing. Succumbing to shortterm temptation is an important reason why our plans to save for old age, or make healthier lifestyle choices, often fail. In his applied work, Thaler demonstrated how nudging Ð a term he coined Ð may help people exercise better self-control when saving for a pension, as well in other contexts.

In total, Richard Thaler’s contributions have built a bridge between the economic and psychological analyses of individual decision-making. His empirical findings and theoretical insights have been instrumental in creating the new and rapidly expanding field of behavioural economics, which has had a profound impact on many areas of economic research and policy.

Source: “The Prize in Economic Sciences 2017 – Press Release”. Nobelprize.org. Nobel Media AB 2014. Web. 14 Dec 2017. <http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/2017/press.html>