Behavioral economics draws on criticisms that have been made about the traditional economic model. In that model, individuals are assumed to be rational actors who are able to sift through information (which is in turn assumed to be perfectly and costlessly available) to make best choices in the marketplace that reflect their underlying preferences—that is, they succeed in maximizing their utility. Such a hypothetical person has been called homo economicus—rational economic man. Oftentimes, however, to achieve this level of rational decision-making, daily decisions require that these sorts of people “can think like Albert Einstein, store as much memory as IBM’s Big Blue, and exercise the willpower of Mahatma Gandhi” (Thaler and Sunstein, 2008, p. 6).
Although one might think that the traditional economic model, based on such strong assumptions, would not stand the test of empirical scrutiny, it nonetheless guided economic thought through almost all of the 20th century.
It was, of course, understood that not everyone always sought out, fully understood, and appropriately used relevant available information before making decisions. But deviations were viewed as minor, and as a result, the model was viewed as sufficient for making accurate behavioral predictions.
The length to which some economists took this thinking is illustrated in a health-related quotation from Nobel Prize winner in economics Gary Becker and University of Chicago colleague Kevin Murphy: “addictions, even strong ones, are usually rational in the sense of involving forward-looking maximization with stable preferences,” and that even though unhappy people often become addicted, “they would be even more unhappy if they were prevented from consuming the addictive goods” (Becker and Murphy, 1988, p. 691). It is hardly surprising that researchers interested in public health have sought an alternative to this type of mindset.
Indeed, there had been detractors over the years. Early on, institutional economists rejected the rational-choice model, with Thorstein Veblen, in 1898, deriding the notion of man as a “lightning calculator of pleasures and pains …” (Camic and Hodgson, 2011). The work of Herbert Simon (1955) is particularly important. Although trained as a political scientist, Simon was keenly interested in economics (winning a Nobel Prize in the field). He formalized the theory of bounded rationality, which recognizes that people do not have the memory and computational wherewithal, much less the time, to use available information to maximize utility. As a result, they instead rely on simpler methods called heuristics or rules of thumb. Rather than being
maximizers, most people, Simon posited, are instead satisficers. As an aside, while one might expect a person who maximizes utility to be happier since she is choosing things that are best rather than “good enough,” the research of psychologist Barry Schwartz (2004) suggests the opposite: on average, satisficers not only make better decisions for themselves, but are happier because they experience less stress over the process, and less regret over the options not taken. In any case, Simon would later be followed by other economists and psychologists who developed even more detailed theories for how individuals make decisions that ultimately give rise to observed behaviors.
Behavioral economics and the decision-making process
One of the criticisms of economic theory is that it ignores people’s decision- making process, focusing instead on observed choices as manifestations of consumers’ purported utility maximization. Borrowing from the field of cognitive psychology, behavior economics, in contrast, focuses on how and why people choose what they do, and therefore provides frameworks to those seeking such an alternative to the traditional economic model. Psychologists Daniel Kahneman and Amos Tversky (1979) introduced such an alternative mechanism through their development of Prospect Theory. Among other things, the theory posited that, rather than comparing the utility of two alternatives, people instead focus on the change in utility of alternatives relative to a reference point, typically the status quo.
In a subsequent refinement, Tversky and Kahneman argued that people’s decisions show both loss aversion (a greater disutility from a loss than they receive in positive utility from a similarly sized gain) as well as diminished sensitivity (where people tend to overweight the utility effects of changes in probability that occur near zero or one, while underweighting those that occur near the middle of the probability distribution) (Tversky and Kahneman, 1992). While too complex to receive full treatment here, the theory can be used to make predictions that are decidedly different than the traditional economic model. In one review, Barberis (2013) provides a number of applications, but interestingly, none from the health care field—further indicating the value of the current book on health care applications.
Another popular model used by behavioral economists is dual-process theory. It postulates that people utilize two very different ways of processing information. Kahneman (2011) popularized this idea using the terminology,
“System 1” and “System 2.” System 1 processing is instantaneous or automatic, like the instinct to jump out of the way of a rapidly approaching car. System 2, in contrast, is deliberative: choosing, say, which model of car to purchase. System 1 decisions, by their nature, cannot follow the traditional economic framework of comparing the benefits and costs of alternatives to maximize utility—although this does not necessarily mean that the choices made are inferior to those made using more deliberative System 2 thinking (Gigerenzer and Goldstein, 1996). It is in System 2 decision-making that traditional economics would anticipate people to succeed in maximizing utility. Due to cognitive biases, however, discussed next, this is not always the case.2