Behavioral economics is all about making our economic models (the tools we use to understand and explain economic behavior) more rigorous and realistic, by building them on solid empirical foundations. It brings into the analytical mix psychological, sociological, neurological, and institutional factors. It adds breadth and depth to economic analysis. Although behavioral economics has grown in prominence over the past two decades, many conventional economists still smirk when it’s mentioned. They see behavioral economics as a bunch of mumbo-jumbo, pop psychology — but nothing could be farther from the truth.

Unlike conventional economics, behavioral economics is devoted to understanding economic phenomena based on actual human behaviors. Behavioral economics doesn’t assume that people must or even should behave in a way that’s deemed rational by conventional economics. The fact is, more often than not, people behave in ways that aren’t consistent with the conventional wisdom.

From the perspective of behavioral economics, people aren’t expected to know everything, to calculate everything in any great detail, or to be narrowly selfish. They are expected, however, to be influenced by the world around them — especially by friends, family, past decisions, culture, and religion. People also are expected to be influenced by how the brain is structured: People’s decisions are affected by their limited abilities to acquire and process information and, therefore, by the need ...

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