Neoclassical Economics vs Behavioural Economics
Neoclassical economics and behavioral economics each seek to explore and explain human choice behavior. Neoclassical economics is the more conventional viewpoint. It does make correct forecasts, especially when it is addressing how consumers and businesses react to shifting prices, however, it does have shortfalls. One of the biggest is deficits is that it views people as being fundamentally rational. The Canadian Center of Science and Education explained what this belief would look like, “In neoclassical theory, the concept of rationality is associated with maximizing net revenue, for example, a total gain. Entities thus act on the basis of their preferences which are given exogenously, whatever they may be. The characteristics of their behavior are thus inferred from the concept of benefits and preferences. The preferences are abstracted from the cultural and social framework and the maximizing entity is understood to be lonely yet having perfect information and the ability of logical calculation. A model of a perfectly calculating and selfish entity is suitable for mathematical modelling. “
Neoclassical economics operates under the stance that while individuals might make initial mistakes when faced with a new situation, the next time they face the situation they will have learned. The result of this should be that mistakes should be rare. Obviously, this is not the case. Systematic errors are rampant. Microeconomics: Principles, Problems and Policies explained behavioral economics approach to systematic errors, “Behavioral economics developed as a separate field of study because neoclassical economics could not explain why people make so many systematic errors… …Behavioral economists err on the side of being messy and vaguely right. As a result, behavioral economics replaces the simplifying assumptions made by neoclassical economics with much more realistic and complex models of human capabilities, motivations, and mental processes.” (Campbell McConnell) Behavioral economics fills the gap of neoclassical economics by choosing to take into account systematic human error.
Herbert A. Simon’s Theories
A leading figure in the school of thought, particularly pertaining to economics, is Herbert A. Simon. Simon was awarded the Nobel Prize in economics in 1978 for his work in economics, particularly how it explored statements that many economists made about how consumers and businesses behave. The Washington Post illuminated his stance when it said, “Simon, using a more psychological approach, postulated that individuals and companies cannot know what actions will maximize their profits or their satisfaction. Instead, he said, they set goals that represent reasonable levels of achievement and try to reach those goals. But such “satisficing” behavior, as Simon called it, does not guarantee that by acting in their own best interests individuals and firms will leave the economy in its best possible position.” (Jr.) Looking back to the previous point discussed, Simon clearly had more of a behavioral view to economics, rather, than a neoclassical view. He did not hold the belief that individuals would be perfectly rational, learning from mistakes, and making the best decision for the entire economy. Instead, he believed that individual’s decisions will not always leave the economy in the greatest conceivable situation.
The current state of behavioral economics within the realm of mainstream economic teaching is that is has been all but one-hundred percent accepted as part of standard economics teaching. It is pivotal to teach both neoclassical and behavioral economics in order for students to have a well-rounded economics education. Some have argued that behavioral economics places too much emphasis on understanding human behavior and using it to justify actions, however, it should be used to understand decisions. The Department of Economics and Business at Aarhus University discussed this intention when it said, “We need reference to self-control problems (time-inconsistent preferences) or self-confidence in order to better understand why many people invest too little in education… …We need reference to behavioral theories of motivation to better understand why relative rank in academic achievement within a class often influences academic outcomes independently from ability” (Alexander Koch) The article later goes on to support the combined teaching of neoclassical and behavioral economics.
Conclusion: Neoclassical and Behavioral Economic Theory
In conclusion, the substantial difference between neoclassical and behavioral economic theory is their views on systematic error. Herbert A. Simon’s research led him to be more in favor of the stance of behavioral economics. At the end of the day, both views should be taught in mainstream economic teaching, as further theories and research are being done on both views every day.