Economic Psychology Of Decision And Choice Research Paper

2. Relation Of Economic Psychology To Other Research Areas

Thus economic psychology is not a branch of psychology, but the interdisciplinary study of the interface—or sometimes the gap—between economics and psychology. One of the most powerful and successful ways of looking at that interface has been through the study of economic decisions, particularly in the areas of risky choice, limitations on rationality, and intertemporal choice. So an article on economic psychology is fittingly placed in this section, alongside discussions of numerous other aspects of decision theory.

A few very distinguished researchers have moved freely between economics and psychology, and are recognized and respected in both disciplines. But many of them would be more likely to identify themselves as decision theorists than as economic psychologists: examples include Herbert Simon, Amos Tversky (see Tversky, Amos (1937–96)), Richard Thaler, and George Loewenstein. It is true in general that many more people do economic psychology than call themselves economic psychologists. Very similar approaches are taken not only in decision science, but also under other interdisciplinary names, such as behavioral economics, consumer science, or socio-economics, and within particular branches of both psychology and economics.

The first use of the phrase ‘economic psychology’ is thought to be in the work of the influential French social psychologist Gabriel Tarde (1902). But the modern development of economic psychology started from the work of the Hungarian-American Gestalt psychologist George Katona, summarized in his Psychological Economics (1975). Recent surveys of current research include Earl and Kemp (1999) and Webley et al. (2001).

3. Economic Behaviors Of Individuals

Economic behaviors include, for example, work, buying, saving, giving, and gambling. Several of these have been subjects of intense research within psychology. Work, for example, is the subject of an entire branch of psychology, variously known as occupational psychology, industrial psychology, or work psychology, and a correspondingly large part of economics, labor economics. It is no accident, therefore, that many economic psychologists have concentrated on economic behaviors such as saving, giving, and paying (or avoiding) tax, which are left aside by the established subdisciplines. When economic psychologists look at topics such as work and buying, it is usually with the aim of integrating them with other aspects of economic life, rather than seeing them in isolation.

The study of saving and debt has been one of the most popular research areas for economic psychologists, for a number of reasons. First, it is macro-economically important. Katona’s consumer surveys focused on how much of their incomes consumers intended to spend rather than save, since quite small changes in this ‘propensity to consume’ can tilt a modern economy into recession or inflation. Second, the problem of optimal intertemporal choice is theoretically interesting, and difficult: economists have often had to appeal to (usually speculative) psychological principles to reconcile their theories with some obvious macroeconomic facts. Third, it is important in the lives of individuals: making adequate provision for future life changes such as children’s education or one’s own retirement is a difficult and complex matter, while getting involved in serious debt or bankruptcy can be a personal disaster. Finally, the problems have proved tractable to psychological investigation. Warneryd (1999) has summarized extensive research that has given us a thorough understanding of the psycho-logical processes leading some people to save more than others. The psychology of debt has only come under investigation more recently, but it is already clear that, though debt is formally just the opposite of saving, the psychological processes involved are quite different.

The psychology of giving has attracted a smaller research literature, but a great deal of popular attention. Gifts illustrate in a vivid way a general principle: every gift is both an economic and a social transaction. Within any society there are well-under-stood, though usually unstated, social rules about what may be given to whom and on what occasions. For example, in the UK money is not an acceptable birthday gift from a young adult to his or her mother. Interestingly, the objections are felt more strongly by the potential donor than by the potential recipient.

Almost all economic behaviors involve money in some way. A central problem for economic psychologists has therefore been the psychology of money itself. The problem is the more acute because modern ‘fiducial’ money is inherently a psychological creation: it is valuable only because we all believe it is. Economic psychologists have investigated what makes ‘good’ money, from the kinds of coins that look and feel valuable to people, to the kinds of electronic payment that do not leave people feeling they are out of control of their spending. They have also investigated some of the unexpected behaviors people show towards money, for it seems to be a general rule that money attracts a certain amount of behavior that is dis-proportionate to its actual economic usefulness. Furnham and Argyle (1998) have collected much of the recent literature on the psychology of money.

4. The Impact Of The Economy On Individuals’ Psychology

At any moment, within any given economy, different individuals occupy different positions, from millionaire to beggar; even the most stable economy undergoes unpredictable macroeconomic changes, from growth to recession; some economies undergo massive transformations, as for example the 1990s transition from state socialism to market capitalism in Eastern and Central Europe and the former Soviet Union; within economies, individual industries and industrial sectors wax and wane; and across the globe there are huge variations between countries in people’s average earnings, spending power, and standards of living. These many different dimensions of economic variation must have profound psychological consequences, yet the economy is traditionally ignored as an independent variable within psychology. Economic psychologists have sought to repair this omission.

A popular methodology has been to look at how children learn to function within the particular economy they are born into. This is known as the study of ‘economic socialization’ (Lunt and Furnham 1996). Many earlier studies took a cognitive stance, investigating how children’s understanding of economic concepts improves with age. More recent work has tended to look at children’s actual economic behavior, and has led us to realize that, as well as interacting directly with the adult economy, children have at least two other kinds of economic life. They are potent influences on the economic behavior of their entire households, both through their unarguable needs, and through their ability to influence their parents’ consumer and occupational choices. In consequence, children are the target of major advertising and marketing campaigns, and the legitimacy and effectiveness of these has been keenly debated. Second, however, children live in an entire economic world of their own, involving exchange transactions that are at best tangentially related to the adult economy. They may show much more sophisticated economic under-standing in these transactions than they reveal in the traditional studies of the development of economic understanding.

Another widespread approach to considering the economy as an independent variable has been comparative study, either cross-sectional or (more rarely) longitudinal. Cross-sectional studies include a series of impressive collaborative cross-national investigations, for example, of economic socialization (Leiser et al. 1990), of tax evasion (Webley et al. 1991), and of attitudes to the new, transnational Euro currency (Pepermans et al. 1998). The many institutional differences between nations mean that such comparisons can give a good insight into the effective economic variables producing differences between people.

Where such formal comparisons are not feasible, ‘impact studies’ have been popular: people in a particular economic position are interviewed or given psychometric tests to try to understand how they differ from more typical populations. Such studies have, for example, looked at the impact of the tourist economy on its host populations (Ap 1992), or at the kinds of coping behavior elicited by living in poverty within a wealthy society (Kempson et al. 1994).

5. The Vexed Question Of Rational Self-Interest

Economics as a discipline is dominated by a single theoretical idea: rational self-interest. Much of economics is theoretical, and much of its theory consists of working out what a rationally self-interested individual would do in a given situation. Psychology, by contrast, has no dominant theory, and its dominant research paradigm is to submit theoretical assertions to empirical test.

Unsurprisingly, two such different disciplines have made uncomfortable bedfellows. Furthermore, the empirical bias of psychologists has led them, as soon as they start to look at economic behavior, to question the economic assumption of rational self-interest. This means that a great deal of research in economic psychology has consisted of investigations by psychologists of the empirical accuracy of theories developed by economists. A smaller amount has consisted of the incorporation into economic theory of psychological principles.

Economic rationality is a protean concept; some have argued, indeed, that it is not a theory at all, more of a general language within which specific theories can be expressed. Economists are not necessarily impressed when psychologists find that, in artificial experiments, some percentage of individuals show a percentage variation from the truly rational behavior pattern: they protest that they are interested in predicting the broad trends of behavior in the great mass of people, so as to explain the performance of the economy as a whole—and they argue that many empirical deviations from rationality are second-order effects of little or no macroeconomic consequence.

Recognizing the various difficulties associated with a frontal assault on rationality assumptions, modern economic psychologists mostly do not test rationality assumptions directly, but rather try to build empirically valid models of the causation and consequences of economic behaviors. Popular causal variables include personality differences, attitudes, socialization experiences, and psychological disorders. All these variables can potentially cause different people, ex-posed to apparently identical economic situations, to react in different ways. They thus allow psychologists to account for some of the individual variation in behavior that remains when the obvious economic variables have been taken into account.

Cumulatively, of course, such studies can still constitute a powerful attack on the economic theory of rational self-interest. There are many ways of acting rationally in any given situation, depending on your knowledge, abilities, values, and goals. If most of the variation between people’s economic behavior actually depends on which rational behavior people choose, and if this has to be predicted from psycho-logical properties of the person, the role of economic psychology has to increase, while the role of rational theory as such has to decrease. How far that process will go remains uncertain; what unites economic psychologists is a belief, based on the fruitfulness of research so far, that it has to go further than it yet has.

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