2-The neoclassical_standard model and behavioral economics in contrast;-18-07-2024.pptx

Introduction to behavioural economics Standard Model Vs Behavioural Economics Textbook Introduction Fundamental study matter of Economics – Allocation of scarce resources. Watching a documentary on television [alternative cost] Making a charitable donation Giving a...

Introduction to behavioural economics Standard Model Vs Behavioural Economics Textbook Introduction Fundamental study matter of Economics – Allocation of scarce resources. Watching a documentary on television [alternative cost] Making a charitable donation Giving a lift to one’s neighbor in order to make it easier to ask them for a favor later Deciding to take a nap rather than mow the lawn Selection of course for UG. Taking pneumococcal vaccine. Economics + other disciplines  What Economists do ? Economics, like any other social science, is concerned with developing theories whose ultimate aim is to help us better understand the world we live in. Economic theories attempt to describe and explain relationships between economic phenomena. A case from US: Many countries experienced a property boom in the years leading up to 2007. Not only have prices fallen substantially since then, but house owners have also been reluctant to sell at these lower prices, as banks have been reluctant to write off bad debt in time. This displays another psychological phenomenon known as the endowment effect: individuals are reluctant to part with what they have acquired even if this is the economically rational thing to do.  Economists explain economic phenomenon/a theory with the support of a number of assumptions or premises. Example: Law of demand and assumptions. Sometimes these assumptions are made explicit (clearly stated: Eg: actual costs), but in many cases they are implicit (not clearly stated but that is understood: Eg: alternative costs), and it is often important to tease out these implicit assumptions: If a theory proves to be inaccurate in its empirical implications this tells us that if we have deduced these implications correctly from the underlying assumptions of the theory, we should query those assumptions themselves.  Behavioral economics is relevant as if increases the explanatory power of economics by providing it with more realistic psychological foundations. Hence, behavioral economics is not seeking to replace the standard framework of analysis. It seeks to add to this framework:  Standard Models (neoclassical economics models) and behavioural economics In order to understand the claims of behavioural economics, and also to understand various critiques of behavioral economics, let us examine the major assumptions underlying the standard model. Generally, standard models are found to be useful even with their unrealistic assumptions. Example: The law of demand.  Standard models Vs behavioural economics : Debate about the methods of standard models. 1- Static models of standard models Vs dynamic models of behavioural economics. Example using the simple market equilibrium model.  Theory of demand and supply– static model – how equilibrium will be achieved.  Explain the process of arriving at equilibrium – importance of time dimension. 2- Subjective Value Judgements [Positive Vs Normative Economics] The standard model of rationality in economics is essentially a decision-making model, which claims to be both descriptive and normative. This means that the model is supposed to both accurately describe Positive how people behave,Normative Economics and to prescribe Economics how they should Factualbehave to achieve a certainValue information given objective. judgments Objective in nature Subjective statements Can be tested Cannot be judged Positive Economics explain the Normative Economics addresses phenomenon (What is?). questions like “what out to be” or “what should be” Eg: Public funded health coverage will Eg: Public funded health coverage will increase the public health expenditure. boost universal health coverage and GDP and sustainable development. helps to gain health benefits.  Integrating both positive and normative economics is unavoidable public policy, private policy. CASE 1: Subsidisation of Covid-19 vaccine in India. CASE 2: Irshad, C.V., Dash, U. & Muraleedharan, V.R. Healthy Ageing in India; A Quantile Regression Approach. Journal of Population Ageing 15, 217–238 (2022). https://doi.org/10.1007/s12062-021-09340-8 [Annapurnna scheme/food grain distribution and healthy ageing]  How Decision-Making Models are Explained by Economists: A Simple Illustration of Standard Models. To make these process more rational and present in a simplest form, Economists often put hard (very rigid) assumptions. In consumer theories, it is assumed two important assumptions (axioms)are necessary: 1.Completeness Individuals entertain a preference ordering across all alternative courses of action that they face (rational). 2.Transitivity Individuals make consistent choices, in the sense that if A is preferred to B, and B is preferred to C, then a rational individual will prefer A to C. These two axioms together ensure that individuals will be able  But for the most part, economists have added stronger assumptions (mostly based on perfect competition) in addition to these rationality axioms, either to simplify technical treatment, or sometimes just out of tradition. Two important additional assumptions, sometimes referred to as the ‘economic’ assumptions that are added to the two rationality axioms above, are that more of an economic good is preferred to less of it (‘monotonicity’), and that averages are preferred to extremes (‘convexity’). These will work only in case of certainty. What about uncertainty and uncertain human behaviour. CASE 1: Decision to take health insurance, how much claim one must have? At what rate one should save for early retirement, say at 58? CASE 2: Irshad, C.V., Muhammad, T., Dash, U. (2023). Extending Work Lives: Lessons from the Determining Factors of Workforce Withdrawal of Older Adults in India. In: Handbook of Aging, Health and  Behavioural perspective on rationality In psychology, rationality is pursued with a different approach. According to Baumeister (2001): ‘A rational being should pursue enlightened self-interest.’ It means; person who act to further the interests of others (or the interests of the they belong to) ultimately serve their own self-interest. The problem of arationality while people take decisions. Why? Example: Selection of health insurance. Lack of perfect knowledge  bounded rationality. Heuristic approach (rule of thumb and time constraints)  bounded rationality. Decision making also relate to attitudes and believes not just choice and actions. Example: Self-reported health/age among older adults. Social desirability bias.  Limitations of the standard model Restrictive assumptions. Standard models are incomplete.