How do behavioural economics findings challenge classical economic theories?

Behavioural economics findings challenge classical economic theories by questioning the assumption of rational decision-making.

Classical economic theories, such as those proposed by Adam Smith and David Ricardo, are based on the assumption that individuals are rational actors who make decisions based on self-interest and the maximisation of utility. These theories suggest that individuals have perfect information, are able to process this information effectively, and make decisions that will provide them with the greatest benefit. However, findings from behavioural economics challenge these assumptions and suggest that human behaviour is more complex.

Behavioural economics, a field that combines insights from psychology and economics, suggests that individuals often behave irrationally, make decisions based on biases and heuristics, and are influenced by a range of non-economic factors. For example, the concept of 'loss aversion', proposed by Daniel Kahneman and Amos Tversky, suggests that individuals feel the pain of loss more acutely than the pleasure of gain, leading them to make decisions that may not be in their best economic interest.

Another key finding from behavioural economics is the concept of 'bounded rationality', proposed by Herbert Simon. This suggests that individuals are not capable of processing all available information and making the optimal decision, as assumed by classical economics. Instead, they make satisfactory decisions based on the limited information they have and their limited cognitive processing capabilities.

Behavioural economics also challenges the classical economic assumption of consistent preferences. Research has shown that individuals' preferences can be influenced by the way choices are presented to them, a phenomenon known as 'framing effects'. For example, individuals are more likely to opt for a medical treatment if its success rate is presented in positive terms (e.g., a 90% survival rate) rather than negative terms (e.g., a 10% mortality rate).

In conclusion, behavioural economics findings challenge classical economic theories by providing evidence that individuals do not always behave rationally, do not have perfect information, and are influenced by a range of non-economic factors. These findings have important implications for economic policy and practice, suggesting that interventions need to take into account the complexity of human behaviour.