Adv Behav Econ pdf

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C A M E R E R A N D L O E W E N S T E I N
The expunging of psychology from economics happened slowly. In the early
part of the twentieth century, the writings of economists such as Irving Fisher and
Vilfredo Pareto still included rich speculations about how people feel and think
about economic choices. Later, John Maynard Keynes appealed frequently to
psychological insights, but by the middle of the century discussions of psychol-
ogy had largely disappeared.
Throughout the second half of the century, many criticisms of the positivistic per-
spective took place in both economics and psychology. In economics, researchers
like George Katona, Harvey Leibenstein, Tibor Scitovsky, and Herbert Simon wrote
books and articles suggesting the importance of psychological measures and
bounds on rationality. These commentators attracted attention but did not alter the
fundamental direction of economics.
Many coincidental developments led to the emergence of behavioral econom-
ics as represented in this book. One development was the rapid acceptance by
economists of the expected utility and discounted utility models as normative and
descriptive models of decision making under uncertainty and intertemporal
choice, respectively. Whereas the assumptions and implications of generic utility
analysis are rather flexible, and hence tricky to refute, the expected utility and 
discounted utility models have numerous precise and testable implications. As a
result, they provided some of the first “hard targets” for critics of the standard 
theory. Seminal papers by Allais (1953), Ellsberg (1961), and Markowitz (1952)
pointed out anomalous implications of expected and subjective expected utility.
Strotz (1955) questioned exponential discounting. Later scientists demonstrated
similar anomalies using compelling experiments that were easy to replicate (Kah-
neman and Tversky 1979, on expected utility; Thaler 1981, and Loewenstein and
Prelec 1992, on discounted utility).
As economists began to accept anomalies as counterexamples that could not be
permanently ignored, developments in psychology identified promising direc-
tions for new theory. Beginning around 1960, cognitive psychology became dom-
inated by the metaphor of the brain as an information-processing device, which
replaced the behaviorist conception of the brain as a stimulus-response machine.
The information-processing metaphor permitted a fresh study of neglected topics
like memory, problem solving and decision making. These new topics were 
more obviously relevant to the neoclassical conception of utility maximization
than behaviorism had appeared to be. Psychologists such as Ward Edwards, 
Duncan Luce, Amos Tversky, and Daniel Kahneman began to use economic 
models as a benchmark against which to contrast their psychological models.
Perhaps the two most influential contributions were published by Tversky and
Kahneman. Their 1974 
Science
article argued that heuristic short-cuts created
probability judgments that deviated from statistical principles. Their 1979 paper
“Prospect theory: Decision making under risk” documented violations of expected
utility and proposed an axiomatic theory, grounded in psychophysical princi-
ples, to explain the violations. The latter was published in the technical journal
Econometrica
and is one of the most widely cited papers ever published in that
journal.

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