Psychological Economics: Developments, Tensions, Prospects (Recent Economic Thought)

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The mental network in which this portion of the psychological process operates is in a constant state of evolution due to the pressure of developmental and societal effects. As individuals go through life, their experimentation in the social world presents them with new connections that, incorporated into their minds, allow them to establish the bounds of socially acceptable behavior Piaget Their experimentation presents them with new connections that increase their knowledge of the relations between the objects and events in their world Dewey These are subject to laws that govern the likelihood they will be incorporated into the mind—increasing, for instance, if connections are actually perceived, and decreasing if the connections contradict the mindset of the individual Festinger The network structure of the mind decays toward nothing the longer it goes unused in the process of making sense of the environment Hayek ; Edelman A useful theory of decision and thus behavior is that people choose to engage in that behavior that is associated with the most preferable implications or behavioral predicates out of all feasible behavior.

Perhaps this choice is trivial if preferences are decided in a qualitative manner by a subconscious cognitive rule in personal knowledge so that the individual is acting out the behavior of the rule more than acting out of a complex process of reasoning. The kernel truth of neoclassical economics—that we do what we think is best for us—is captured in this analysis, but the theory developed on this truth is revealed to be a special case of a far broader perspective on socioeconomic behavior for we do what we think is best for us.

Neoclassical economics is placed within a context, and, within that context, it has an effect on behavior at the margin, but it can only be understood at that margin as operating within a broader context. Once we understand the environment in which behavior takes place and the mental networks that guide the process of thought and have been shaped by a process of social development operating on an evolutionary basis, then we can understand the role of changing incentives at the margin.

Not before. If certain technical conditions are met, then a change of prices may make two courses of action equally preferable, at which point an individual may be induced to change behavior by a further change of incentives. Ironmonger and Lancaster a, b have applied this principle of substitutability to changing attributes. But how do people behave if no state of substitutability exists between two courses of action? The perspective offered by Earl , , a, b, , , Drakopoulos , and Drakopoulos and Karayiannis advances our knowledge in this regard. If no state of substitutability exists, the requirements created by simple cognitive rules in the psyche may establish cutoffs that restrict courses of action and render tradeoffs moot.

Further, some complementarity between various courses of action may result in resistance to adopting some behavior, which renders tradeoffs moot. A change in behavior might therefore require a change in technology in order for requirements and complementarities to be obtainable.

But if we still find such breaks in the chain of substitution, then we require a more holistic view of psychosocial factors before we can understand how behavior changes fully.

Account Options

Suppose no state of substitutability exists for some feasible socioeconomic behavior. We can readily identify the necessary conditions for a behavior to nonetheless be adopted by the individual. First, individuals must have some understanding of the behavior they are to engage in. If there are no connections to this behavior in their mental networks, they cannot understand how it relates to events in the world or appraise it.

That knowledge must be developed or learned, which is most likely when it is communicated simply with few connections and noticeably connects objects with a significant salience and builds on existing ideas in the mind without contradicting existing mindsets or changing personalities at their core. Experimentation and play are powerful means by which such knowledge can be developed for this reason Dewey ; Piaget ; Panksepp They immerse individuals in an environment they understand, and a simple new idea is presented to them that modifies their understanding a little.

Psychological Economics : Developments, Tensions, Prospects

Similarly, ideas expressed in narrative structures as stories are a particularly potent way of communicating such knowledge and influencing behavior for this reason Shiller Not only is the information in our environment contingent on interactions with others, the very structure of our minds is shaped by our interaction in society. Second, the individual must have that knowledge called to mind in the relevant environment that is associated with the most preferable feelings of expectation or satisfaction out of all feasible courses of action.

At least one of two requirements imposed by perception must therefore be met Vernon One possibility is for the information that corresponds to percepts of objects or events to be sufficiently salient to make a strong sensory impression in its own right. Alternatively, the information that correlates to percepts of antecedent objects or events that are sufficiently strongly connected to those objects or events must be sufficiently salient for them to be perceived.

The information in the environment must therefore be framed in such a manner that calls to mind the objects and events that, connected together, become the most preferable feeling of anticipation or satisfaction. Thus procrastination or myopic behavior might occur not because of hyperbolic discounting of the future, but because costs were moved out of the salient present and into the future, which is removed from our senses Rick and Loewenstein Connecting objects and events in the environment to form a feeling of anticipation or satisfaction may cause an individual to act in certain ways.

The effect of the connection on preferences is captured by the idea of anchoring. Anchors are ubiquitous in the mind as axes of classification, without which, as Kelly and Hinkle taught, we cannot make sense of any object or event. Mental networks are rarely fully modular. They contain significant interconnectivity between concepts. The classic example of this in economics is the anchor of peer income or consumption.

Psychological Assumptions of Economic theory

They could be needs, which have the effect of breaking the chain of substitution and categorically ruling certain courses of action out of consideration if there is any possible alternative Earl a, b ; Blatt ; Ironmonger ; Maslow So there is a relatively simple process we can use to understand why, outside of inducement and incentive, the individual acts in a certain way. It depends on social, environmental, and historical contexts. That knowledge must be elicited by the framing of information in the environment such that the objects and events it relates together are salient, or the objects and events strongly connected to them in mental networks are salient.

But these dynamics also provide the foundations for an evolutionary and institutional systemic perspective on socioeconomic systems. The socioeconomic system is a complex evolving network of interactions among individuals acting on the basis of their psychology, social psychology, and socioeconomic environment Potts ; Foster ; Earl and Wakeley The above theory of the psychological process operating within and upon networks to determine behavior provides a theory of behavior that may be nested within such a perspective on socioeconomic systems, and thus serve as a foundation for an institutional and evolutionary perspective on socioeconomic systems.

This model reveals the importance of selection rates by which an anterior population of rules for behavior are reconciled to a posterior population Witt ; Metcalfe , We begin from a state of ignorance and uncertainty where little is known of the future of socioeconomic interaction. Furthermore, the knowledge of how and why to provide goods or services on the one side of the interaction, and obtain them on the other, must be then elicited by the environment in which the individuals find themselves to organize socioeconomic interaction. At this point, incentives may have an effect at the margin.

They will cause it to evolve as they are selected, retained, and integrated into the broader set of rules that organize socioeconomic systems. These rules are subject to origination and diffusion across society and to a process of variation, selection, and retention and therefore to the evolutionary process of reconciling an anterior population of rules with a posterior set of institutions that serve to order socioeconomic interaction. The model we have introduced here provides a perspective on the manner in which selection pressures are differentially applied to these rules in order for them to become institutions.

Rules for guiding thought and behavior are diffused across the population, selected at differential rates, and retained as institutions as they are incorporated into the minds of individuals. These institutions are communicated by development, learning, or socialization processes, all of which communicate ideas about how to behave in society, but simple argument and debate in the public sphere are also relevant processes.

Our theory thus brings developmental psychology, sociology, and political science deeper into economics at the very core of the discipline in its model of socioeconomic behavior. Our theory explains which of these ideas will be incorporated into the mind at differential rates across the population and thus retained as institutions. As new rules for guiding thought and behavior are originated and diffused, socioeconomic structures in which they manifest will evolve as well.

The new microeconomics has primarily an individualist methodology Hodgson However, we can now see that it is not so crude as to treat individuals as if they were isolated. Not only do others influence the environment upon which their psychology acts, social interactions affect the very basis for their psychology by causing mental networks to evolve.

The individual exists within a socioeconomic environment in relation to others, observing others, and interacting with others in an institutional environment and evolutionary system. It also has significant practical value in improving the formulation and implementation of strategy and policy. We can see its practical value by applying it to some microeconomic policy problems. Specifically, there was little knowledge of how to enter into markets with new businesses to challenge monopolies.

They also needed a relatively stable regulatory system, but that was not forthcoming. Even more basically, they needed knowledge of how to operate within the new legal system, but it first had to be formulated.


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In other words, there was insufficient knowledge of the radically new institutions within the former Soviet bloc, and the institutional system was too unstable for states of substitutability to exist between prior modes of socioeconomic behavior and new modes for any sort of meaningful competition to develop. The newly freed market failed to emerge before state capture occurred. If we take the Australian experience of privatization, now we see reasons why it was relatively positive, while still mixed.

The Australian regulatory and legal environment was stable for the period of privatization. Reforms were extensively debated in public and systematically planned before being implemented. Nevertheless, while knowledge was available of the technologies that allowed new entrants to markets, knowledge of how to apply them effectively was insufficient to guarantee a state of substitutability between previous modes of behavior in a monopolistic market and a competitive market.

One must have vast resources before being able to meet the requirements imposed by customers for telecommunications services, let alone provide complementarities like landline, mobile, and Internet packages. Regulatory requirements alone make it prohibitive for new banks to enter the market, and the only real competition the Big Four have encountered has come from allowing other financial institutions to offer banking services.

That theory assumed a state of substitutability between behavior in a heavily nationalized economy and in a privatized economy that was open to competition. But it did not exist in reality because the institutional structure of society was too disrupted and unsettled or simply too set against competition for the requisite knowledge of how and why to behave in new ways to emerge.

International Political Economy and Development

Policies to reduce emissions of greenhouse gases provide another arena in which to compare competing theoretical perspectives. This is straightforward neoclassical economics. But rational choice theory about incentives is predicated on the theory of substitution, and there is no reason to assume that a state of substitution exists between existing technologies that create emissions and new technologies that do not.

In Australia, neoclassical economics was directly applied to the formulation of climate change policy. Carbon emissions increased by several megatons, even while household electricity prices increased by at least 10 percent Robson This does not even account for an earlier price rise likely brought about by an uncertain policy environment. Electricity is a necessity for most households and businesses, and they require a certain quanta of it regardless of prices unless those prices become prohibitive.

But there was no readily available substitute technology in Australia by which that electricity might be produced without incurring a substantial tax on emissions. The critical assumption of substitutability, on which neoclassical analysis in favor of the tax was based, was incorrect. The technologies exist by which emissions might be reduced natural gas, solar, wind, water , but they were not adopted, in part due to regulated requirements of security, resilience, and redundancy across the system, as well as simple, but massive, infrastructure requirements imposed by engineering concerns.

This is the problem of framing. Changing electricity suppliers is no small matter in Australia. It only became possible in the decade before the carbon tax was introduced, and the bureaucratic entanglements alone were a nightmare. Furthermore, there were few means of comparing supply contracts, which can be complex even for persons with knowledge of the market. That might have constrained perception of the possibility of changing suppliers. The Australian government made no effort to frame the environment of households and businesses in a way that they could perceive the possibility of substitution to a low emissions supplier.

Without that possibility, all theories about substitution from high to low emissions technologies were entirely moot. The assumption of substitutability upon which it was predicated was not met in reality due to regulatory and engineering requirements, and very little consideration was given to framing choices so that consumers could consider alternative electricity supply technologies.

Why We Need a Multidisciplinary Economics

The central problem of business strategy is the problem of how to grow and maintain the custom of a business venture. This is, incidentally, the central question of the two great seminal texts of evolutionary economics by Nelson and Winter and Metcalfe Once each is established, the strategy grows stronger as each of these dimensions grows stronger and complements each other.

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International Political Economy and Development < Fordham University

The first requirement for a strategy that will allow a business to grow and maintain custom is an engineering one: a company must maintain a product that meets evolving consumer requirements and that provides adequate complementarities with other products in the market. This is all important. A company must, however, also heed the studies of Granovetter , , who argues that economic action is embedded within a socio economic system, not merely an economic system. Unless knowledge of how to obtain its product can be spread through social networks, all other considerations are moot since the potential customer does not even imagine being a customer.

Hence the second requirement of a strategy that will allow a business to grow and maintain custom is marketing: the company must be able to craft a persuasive narrative about how and why to buy its product. A company looking to develop good strategy needs good storytellers who are aware of the structure of society and means of communication. Beyond these necessities for good strategy, without which any further strategy is irrelevant, a business needs a strategy in which knowledge of how and why to buy its product is actually elicited by the environment in which the business exists.

This requires first that the environment be framed such that information corresponding to the product is placed prominently in the environment where it will have a significant impression on the sensory organs. This is again a problem of marketing and literal advertising. At this point, a state of substitutability might exist between current behavior and buying the product, so incentives also become important.

It is essential for the customer to be able to afford the product, so the benefits of buying it need to exceed its price. A good strategy must therefore have a marketing element that ensures the requisite knowledge of how and why to buy the product is called to mind in the business environment, but it must also have an economic component that provides a sufficient incentive for the customer to buy the product. We can see that in the realm of strategy, as in the realm of policy, neoclassical economics is not wrong, but it is incomplete.