Behavioural Economics Model Vs Traditional Economic Model

Behavioural Economics

Kruti Nair (1422038)

Topic: Illustrate how BEM is more superior to standard economic model in terms of power of explanation and prediction using a variety of empirical examples form both observational and experimental studies.

What is Standard Economic Model?

An economic model is a simplified framework to represent complex processes. The Standard Economic Model (SEM) deals with three basic assumptions 1. Unbounded rationality 2. Unbounded selfishness 3. Unbounded willpower. These assumptions are highly unrealistic in nature as no individual is expected to have the above three. SEM defines the economic agents as people that have unlimited information and who can process capabilities. People are endowed with ability to

Application of the two into industrial organisation models has helped the firms to a great extent. According to ( DellaVigna, Gabaix and Liabson 2006, Kamenica 2008, to name a few) the firms have come to know how the contracts should be designed and structure products keeping the customer’s psychological biases in mind so that it is easy to sell them the product. The studies have shown that the customers sometimes cannot predict their own demand. Example a person deciding to go to gym pays flat contract fee, whereas he may actually use the gym very rarely. He could have actually saved the money by going for the pay-per-use policy. This in the behavioural economics is best explained by one model in which people overestimate the precision of their demand forecasts – this relates to the types of overconfidence. There are empirical studies that show patterns of “projection bias” where the customers neglect how their preferences might

It is being incorporated in the models of almost all the fields to get a better understanding of the core concepts. It is not that behavioural economics is generating a new wing of psychology altogether or trying to transform the existing models within psychology. The value that Behavioural Economic Models is bringing to psychology is providing evidence that the concepts are applicable in the real world decision – making. Hence if the Standard Economic Model and the Behavioural Economic model are taken into consideration, then we can definitely say that the assumptions on which the SEM is based are very unrealistic. And unrealistic assumptions give out unrealistic results or predictions that might not hold any significance for the policy making. On the other hand if the BEM is looked at, the assumptions involve the reality and takes into consideration the psychological concepts and aspect that go behind decision making of an individual, This helps the policy makers to predict the decision, demand and behaviour of an individual in a much better manner than he could have using SEM. This accuracy in prediction gives clear picture to the policy makers to formulate the policy in such a manner that the desired results are achieved. Also, the theories that come under SEM states certain things. But in real world, if we try