Tag: behavioural economics

Whilst some economists predicted the banking crisis of 2007/8 and the subsequent global recession, many did not. Was this a failure of macroeconomics, or at least of certain macroeconomic schools of thought, such as New Classical economics? Or was it a failure to apply the subject with sufficient wisdom? Should the subject be radically rethought, or can it simply be amended to take into account aspects of behavioural economics and a better understanding of systemic risk?

The four linked articles below from The Economist look at the debate and at the whole state of macroeconomics. The other articles pick up some of the issues.

Will the ‘crisis in macroeconomics’ lead to a stronger subject, more able to explain economies in crisis and not just when they are working well? Will a new consensus emerge or will economists remain divided, not only about the correct analysis of how economies work at a macro level, but also about how to tackle crises such as the present recession?

What went wrong with economics The Economist (16/7/09)
The other-worldly philosophers The Economist (16/7/09)
Efficiency and beyond The Economist (16/7/09)
In defence of the dismal science The Economist (6/8/09)
How to rebuild a shamed subject Financial Times (5/8/09)
What is the point of economists? Financial Times – Arena (28/7/09)
Macroeconomic Models Wall Street Pit (23/7/09)
Macroeconomics: Economics is in crisis – it is time for a profound revamp Business Day (27/7/09)

Questions

  1. Distinguish between ‘freshwater’, ‘saltwater’ and ‘brackish’ macroeconomics.
  2. Explain why economists differ over the efficacy of fiscal policy in times of recession. To what extent does the debate hinge on the size of the multiplier?
  3. Why is the potential for macroeconomics higher now than prior to the recession?
  4. What is meant by the ‘efficient market hypothesis’? How did inefficiencies in financial markets contribute to the banking crisis and recession?
  5. Should economists predict the future, or should they confine themselves to explaining the present and past?

Imagine putting together a dream team of economists to tackle the current recession. Who would you choose? Larry Elliott, the Guardian’s economics editor considers this game of ‘fantasy economics’ in the linked article below. In the process, he makes a number of criticisms of economists for saying little about what caused the current crisis and how such crises could be avoided in the future.

As students studying economics you might want to defend economists against this attack. After all, virtually every time you turn on the radio or television or open a paper, there are economists explaining what has happened and what should be done about it. So see if you can mount a defence against this attack – and maybe put together your own dream team of economists!

It’s a funny old game: where is the dream team of economists to tackle the slump? Guardian (1/6/09)

Profiles of many the economists referred to in Larry Elliott’s article can be found at the History of Economic Thought website. You can access this from the Sloman Hot Links tab above and then click on site C18.

Questions

  1. Explain why economies with deregulated financial markets are likely to experience macroeconomic instability (‘boom-bust cycles’).
  2. What are the benefits of studying perfectly competitive markets and general equilibrium theory?
  3. Write a brief defence of the use of mathematics in economics.
  4. Does experimental economics allow economists to take a ‘more nuanced and relevant approach’ to studying economic behaviour and devising appropriate policy?

The following articles look at a recently published book by George Akerlof of the University of California, Berkeley, and Robert Shiller of Yale. They examine the role of what Keynes called ‘animal spirits’ and is the title of the book.

The motivation to make economic decisions (to buy, to sell, to invest, etc) may not be ‘rational’ in the sense of carefully weighing up marginal costs and marginal benefits. Rather it can be one of over-optimism in good times or over-pessimism in bad times. Just as individuals have ‘mood swings’, so there can be collective mood swings too. After all, confidence, or lack of it, is contagious. This motivation that drives people to action is what is meant by animal spirits.

But are animal spirits a blessing to be nurtured or a curse to be reined in? Should governments seek to constrain them?

An economic bestiary The Economist (26/3/09)
Good Government and Animal Spirits Wall Street Journal (23/4/09)
Irrational Exuberance New York Times (17/4/09)
Animal Spirits: A Q&A With George Akerlof Freakonomics: New York Times blog (30/4/09)

Questions

  1. Describe what is meant by ‘animal spirits’ and their effects on human behaviour.
  2. Why may animal spirits make economies less stable?
  3. How may animal spirits help to explain exchange rate overshooting?
  4. Discuss whether governments should seek to constrain animal spirits and make people more ‘rational’? Also consider what methods governments could/should use to do this?

Behavioural economics looks at the way in which people behave when making economic decisions about spending. It looks essentially and what people buy and why they buy it. Research in behavioural economics has started to question some of the traditional economic assumptions of rationality and argues that habits and other psychological factors may be more important than conventionally assumed.

Why we buy what we buy Guardian (20/5/08)

Questions

1. Explain what is meant by ‘behavioural economics’.
2. Evaluate the principal factors that people take into account when choosing to buy a consumer good.
3. “….. average people are all far more irrational and more human than economists allow”. Discuss the extent to which this might be true.

In the article below Tim Harford (the Undercover Economist) looks at rationality in the purchase of cigarettes. He consider whether healthy and happy smokers are the same thing and the extent to which smokers would be happier if cigarettes were more expensive.

Why smokers are happier when cigarettes cost more MSN Slate (17/5/08)

Questions

1. Identify the principal factors that determine the level of demand for cigarettes.
2. Given the factors identified in part (a), discuss the likely value of the price elasticity of demand for cigarettes.
3. Discuss the extent to which higher cigarette prices would make smokers happier.