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(originally published by Booz & Company)


Best Business Books 2004: Behavioral Economics

The Not-So-Dismal Science

When I'm asked at a party, "What do you do?" the reply "I'm an economist" is, I've always found, a conversation killer. After all, the public persona of the profession is a gray suit spouting jargon on financial news programs. Most professional economists have a difficult to nonexistent relationship with clear prose, perhaps because so often they bring bad news. The academics disdain attempts to popularize their work, and most of the popularizers are dull, too. (I exclude myself here, of course.) But I'm optimistic about becoming less of a social outcast, because economics is reaching out beyond its conventional narrow boundaries and getting more interesting.

Just as science and history have found popular audiences, three new books suggest economics could do the same: The Economy of Esteem: An Essay on Civil and Political Society, by Geoffrey Brennan and Philip Pettit (Oxford University Press, 2004); The Paradox of Choice: Why More Is Less, by Barry Schwartz (Ecco, 2004); and The Company of Strangers: A Natural History of Economic Life, by Paul Seabright (Princeton University Press, 2004). None is a straight popularization of a conventional part of economic knowledge. Instead, each is an example of how economists are taking an interdisciplinary approach to their research and writing, which is helping make their work more accessible and relevant. Some of the best economists have always done this: Think of past winners of the Nobel Prize in economics, such as Herbert Simon, for his insights into how real-life businesses make economic decisions; or Gunnar Myrdal and Friedrich August von Hayek, for their insights into the ways social and economic institutions shape each other.

Today, economists are increasingly making links to history, law, urban studies, biology, anthropology, and psychology. This is a change since the mid-1980s, when most academics worked in the neoclassical tradition of abstract models of profit- or income-maximizing rational individuals. So strong has the trend been that the borders of the subject are becoming mainstream.

Stuck with Choice
In The Paradox of Choice, Barry Schwartz, a professor of social theory at Swarthmore College, draws on a growing body of research into how psychology affects economic outcomes -- and how economic outcomes affect our psychology -- to address two questions: Do the facts of human psychology mean that, contrary to a basic postulate of economic theory, we do not make choices rationally? And does prosperity actually make us happy?

The answers provided by this very readable and stimulating book are, in brief, yes and no, respectively. According to economic theory, more choice is inevitably better. People can always look at the alternatives, figure out what benefits they expect to derive, and decide whether or not to buy. But even aside from the time taken to assess all the choices, our psychology means we don't evaluate the alternatives in this purely objective way. There is increasing evidence that people's choices diverge in quite systematic ways from the rational ideal of economic textbooks. For example, most of us prefer small, reasonably sure gains to large but uncertain ones, even if the expected outcomes (the size of the gain multiplied by the probability of its occurrence) are the same. Most people fear losses more than they desire gains. And all our choices depend on what we start with and how we think about or "frame" them: A discount off a high price for paying cash and a surcharge on a low price for paying on credit are perceived very differently even if the final price is the same in both cases.

The implication is that more choices can actually make us worse off. A Sony CD player is on offer at $99, a great price. Researchers cited by Schwartz found that 66 percent of the people they surveyed would buy it without searching any further and 34 percent would not buy. Yet offered a choice between the Sony at $99 and a top-of-the-line Aiwa at $169, 27 percent would buy the Sony, 27 percent would buy the Aiwa, and 46 percent would wait. Faced with a trade-off between price and quality, nearly half the potential customers would avoid a purchase altogether. Schwartz comments: "When people are presented with options involving trade-offs that create conflict, all choices begin to look unappealing."

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