Misbehaving

Accounting for Human Behavior in Economics

Economics is the most influential of the social sciences because of its far-reaching foundational theories and their impact on people’s lives. These theories say that individuals always make optimal purchasing decisions within their budgetary constraints and that free markets tend toward a state of equilibrium in which the supply of a good or service equals its demand.

But these assumptions are faulty. Ideal decision making is impossible for ordinary people. Consider the act of shopping at a supermarket. With the countless goods available, how can individuals always make the best choices? Optimizing is even harder in such tasks as choosing a spouse; high divorce rates suggest that marital selections are hardly optimal.

Unbiased decision making is another flawed staple of economic theory. Economic models have substituted the human being, or Homo sapiens, for “a fictional creature called Homo economicus,” or “Econ,” a perfectly rational decision maker who always optimizes. Real human decision making often amounts to “misbehaving” in the artificial world of economics, so forecasts based on the rational...