Behavioral economic theory: a methodological breakthrough or extension of the boundaries of dominant orthodoxy?

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Behavioral economic theory: a methodological breakthrough or extension of the boundaries of dominant orthodoxy?

O.Nesterenko, PhD in Economics, Associate Profesor

The article is devoted to the analysis of the place of behavioral approach in the structure of modern economic study. The evolution of views on the essence of economic behavior of individuals is described and the peculiarities of approaches to its definition of different economic schools are analyzed. The comparative analysis of behavioral and neoclassical approaches is presented; the peculiarity of the used method is the presentation of the neoclassical direction not in the aggregate, but as two main branches - cardinal and ordinal, which allowed for a more detailed analysis. The analysis revealed differences and some similarity of these directions of research. According to the findings, it is concluded that the behavioral approach is not the complete opposite of the neoclassical, but has a significant number of features close to the ideas of ordinary people, so it can be considered as a natural continuation of established ideas deepened through the use of an interdisciplinary approach. The article also outlines possible options for the development of neoclassical and behavioral approaches and the current issues for further research.

Key words: behavioral economics; economic behavior; rationality; individual decision-making process.

ПОВЕДІНКОВА ЕКОНОМІЧНА ТЕОРІЯ: МЕТОДОЛОГІЧНИЙ ПРОРИВ ЧИ РОЗШИРЕННЯ МЕЖ ПАНУЮЧОЇ ОРТОДОКСІЇ?

Присвячено аналізу місця поведінкового підходу в структурі сучасних економічних учень. Досліджено еволюцію поглядів на сутність економічної поведінки та проведено порівняльний аналіз поведінкового й неокласичного підходів до економічної поведінки, причому останній представлено окремо ординалістською та кардиналістською версіями. Виявлено їх відмінності та спільні риси, а також окреслено можливі варіанти розвитку і взаємодії неокласичної та поведінкової економічних теорій.

ПОВЕДЕНЧЕСКАЯ ЭКОНОМИЧЕСКАЯ ТЕОРИЯ:МЕТОДОЛОГИЧЕСКИЙ ПРОРЫВ ИЛИ РАСШИРЕНИЕ ГРАНИЦ ГОСПОДСТВУЮЩЕЙ ОРТОДОКСИИ?

Посвящено анализу места поведенческого подхода в структуре современных экономических учений. Исследована эволюция взглядов на сущность экономического поведения, проведен сравнительный анализ поведенческого и неоклассического подходов к экономическому поведению, причем последний представлен отдельно ординалистской и кардиналистской версиями. Выявлены их различия и общие черты, а также определены возможные варианты развития и взаимодействия неоклассической и поведенческой экономических теорий.

Introduction

behavioral economic doctrine

The problem of determining the nature of economic behavior remains one of the most relevant areas of economic research today, as each individual makes many economic decisions every day and chooses among several alternatives. It is such a daily choice of each person that shapes the specificity of consumption at the macro level, which has a significant impact on both the national economy and the global economy.

Studies of individual behavior began a long time ago, the first substantial concept of economic behavior was the model "Homo economicus" by A. Smith, which has long been the basis of many further studies. Subsequently, many anomalies and inconsistencies were identified in the consumer choice process, which could not be explained by this approach. This led to the emergence of other concepts of economic behavior that took into account social, religious or mental factors and studied the consumer in various aspects. However, the most profound questions about consumer behavior and economic decision-making have been explored by behavioral school representatives, who have taken into account not only economic but also psychological factors, finding that in practice consumers are overwhelmingly irrational.

Behavioral economic theory has always been defined as an alternative to the neoclassical direction, a fundamentally opposite approach. However, at the present stage, more and more scientists are assuming the possibility of synthesis of two directions in the near future. Despite all the differences in methodology, views on rationality and economic behavior, behaviorism has every chance of integrating with the teachings of the neoclassicists and contributing to the development of the economic mainstream.

Literature review

Supporters of the cardinal approach (including A. Marshall [1]) and supporters of the ordinal approach worked on the development of the neoclassical model of individual behavior. The basis of the behavioral direction was the research of H. Simon [2] and G. Catona, which were developed by D. Kahneman and A. Tversky. Modern researchers of the human model in economics are K. Binmore [5], R. Thaler [6], D. Ariely [7]. Among Ukrainian scientists who have been researching economic choice and behavior, S. Slukhay [8], P. Illiashenko [9], O.Dluhopolsky [10].

The purpose of the paper is exploring the neoclassical and behavioral approaches, their common and distinctive features, as well as linking directions in the context of developing views on the nature of economic behavior, and analyzing possible ways of developing and further interacting approaches.

Research methodology

To achieve the purpose of the paper and solve certain problems, we used general scientific and special methods of scientific knowledge: comparative analysis - to identify the strengths and weaknesses of neoclassical and behavioral approaches; historical method - for a retrospective analysis of approaches to determine the features of individual choice; cluster analysis - to identify features of ordinal, cardinal and behavioral approaches, establish commonality and distinctive features; analysis and synthesis - to develop suggestions for further interaction of directions. An interdisciplinary approach is used to determine the nature of behavioral economic theory and to explain the characteristics of individual decisions.

The main results

Economists for centuries have been searching for the answer to the question of the role of individual in the economy, offering new hypotheses about the nature of its economic behavior. However, there is still no definite opinion. The attitude to determining the role of the consumer in the economy is formed in accordance with the basic assumptions made within each direction or school of economic theory.

The classical concept of the human behavior model was based on the theoretical concept of "Homo economicus", proposed by Adam Smith, which became one of the first attempts to study the nature of economic behavior and was established as a basic model for a long period. According to its model, the individual is endowed with such innate qualities:rationality, selfishness, individual economic interest, propensity to exchange and independence from the actions of other individuals. A. Smith also believed that each person clearly defined and followed their own interests. That is,the classical school of political economy views a person as an active economic subject, whose behavior is dependent on his own selfishness and satisfaction of his own needs in condition of the free choice. A. Smith's theory was the basis of many further developments, but it should be noted that it had a number of disadvantages and did not cover the full range of factors that influence the economic decision-making process.

An interesting fact is that the "father" of the concept of economic man A. Smith is also considered one of the first behavioral economists. Analyzing the earlier work of the scientist, "The Theory of Moral Sentiments" (1759), researchers N. Ashraf, K. Camerer, and J. Loewenstein write: "Adam Smith's actors in The Theory of Moral Sentiments are driven by an internal struggle between their impulsive, fickle and indispensable passions, and the impartial spectator. They weigh out-of-pocket costs more than opportunity costs, have self-control problems and are overconfident. They display erratic patterns of sympathy but are consistently concerned about fairness and justice. They are motivated by ego more than by any kind of direct pleasure from consumption and, though they don't anticipate it,ultimately derive little pleasure from either. In short, Adam Smith's world is not inhabited by dispassionate rational purely self-interested agents, but rather by multidimensional and realistic human beings" [11]. Such ideas of A. Smith were too progressive for the scientific community of the time, and the factors that he considered in explaining the economic behavior of man, were again investigated by economists only two hundred years later.

At the beginning of the XIX century, within the doctrine of utilitarianism became famous the teachings of English philosopher and sociologist I. Bentham, which is based on the study of utility. Exploring the principles of usefulness, the scientist not only sought an explanation for human behavior, but also gave it a normative value. The Bentham Man is guided by the principles of selfishness and oriented toward consumption rather than labor, unlike the economic man A. Smith. The usefulness of any decision is defined as an assessment of the degree of its morality, and the level of positive or negative results of the decision as the level of happiness or suffering of the individual.

Representatives of the new history school considered it necessary to take into account psychological factors in the study of economics, considering the person as a capitalist entrepreneur, seeking self-determination and power. M. Weber, exploring different spheres of social life, concluded that religious and ethical values are the cause, and economic behavior of man is the consequence. It is ethical values that are an important factor in economic development. It should be noted that the representatives of the German historical school of Economics were sharp opponents of the concept of economic man.

A fundamentally new approach to explaining human behavior is applied to the theory of marginalizm that emerges in the last third of the XIX century. There is a new method - the method of "Robinson economy", according to which the simulation of the situation where the individual is a solitary economic entity with a limited number of goods. That is, for the first time in economic science, the personal desires and needs of the consumer are studied, and a combination of psychology and economic theory is formed, which becomes the first step to a deeper study of both the needs of the individual and the essence of his choice and behavioral motives.

An important step in making sense of the economic decision-making process is the theory of rational expectations, formulated by J. Muth in 1965 and later developed by R. Lucas. Unlike adaptive expectations, which are based on past experience, rational expectations are based on scientific assumptions that take into account the functioning of the real economic model. According to proponents of the theory of rational expectations, economic agents can predict the consequences of influence on the economy, based on knowledge of the laws of its functioning, accordingly, shaping economic behavior. They predict their activity, and these forecasts are usually closer to reality than those obtained through modeling.

Each step of the previous research has become an important component in the formation of two predominant directions that study individual economic choice and economic behavior - neoclassical and behavioral. To analyze the interaction and possible integration of the achievements of two alternative directions, let us consider each of them.

The methodology of neoclassical economic theory, as well as the basis of classical political economy, is based on the concept of rational behavior of economic subjects, although compared to the classics, they view individual as the subject of study of economic science. The neoclassical school of economic theory has made a significant contribution by formalizing the concept of "economic man" for use in mathematical models. In the future, a simplified version is used - a comparison of a person with a factor of production. However, neoclassicals made some attempts to make the consumer model more convincing.

For example, A. Marshall, the founder of the neoclassical school, believed that habits and irrational behavior underlie many human actions, and noted that not only economic but also religious factors influence the decisions of the individual . The scientist has brought the human model closer to the behavior model of real economic agents - managers.

Marshall wrote that attempts were made to construct a certain abstract science of the actions of an "economic man", free from moral principles, which earns money methodically and selfishly [1]. The model of human behavior, created by A. Marshall, became the basis of the model of modern economic man in neoclassical economic theory.

In exploring the problem of consumer choice, proponents of neoclassical theory are guided by the principles of utilitarian doctrine, meaning that every consumer, when making a choice, distributes the budget in such a way as to maximize utility. However, in order for the consumer to decide which choice maximizes utility, it must be measured. That is why, within the neoclassical approach, two concepts of utility have emerged - the cardinal and the ordinal.

A cardinal (quantitative) approach to determining utility was proposed in the last third of the nineteenth century by W. Jevons, K. Menger, and L. Walras. The theory is based on the hypothesis that the utility of various benefits can be measured [13]. Adherents to this approach also became A. Marshall, but theory received much criticism from F. Edgeworth, W. Pareto, and I. Fisher, who later developed their own alternative utility theory. In addition, the research of cardinal utility theory was based on the following hypotheses: the consumer distributes the budget so as to obtain maximum satisfaction (utility); the consumer is able to quantify the measure of satisfaction of his own needs with a specific economic benefit in special utility units - utiles; in the consumption of each good can be calculated total and marginal utility [13]. In addition, the approach provides an explanation of the individual's attitude to the value of a particular good, depending on the change in its quantity, as well as an explanation of the wishes of the participants of the exchange. With the satisfaction of the needs of certain goods, their value falls; each participant strives to maximize the benefits by distributing their funds between different purchases. He intends to receive the same satisfaction from each amount of money spent on each of the goods he wants to buy. The cardinal approach has received much criticism because the basis of the theory - the assumption of the possibility of measuring utility, which is in fact subjective, cannot be universally calculated for every good and cannot be objectively assessed by the individual.

The main difference between the ordinal and the cardinal approaches is the assumption that the individual does not need to quantify the usefulness of each good, but to order the good according to the degree of usefulness received. Proponents of the ordinal approach were F. Edgeworth, W. Pareto, S. Fisher, J. Hicks, and E. Slutsky. According to this approach, the consumer seeks to maximize utility and make choices based on axioms of complete orderliness, transitivity, saturation, and independence. Rationality of the consumer over time has caused some inconsistencies in practice and has proven the imperfection of the model. As we can see, the ordinal approach has many advantages over the cardinal - it is less subjective. However, the ordinal approach has significant drawbacks, because it does not take into account the influence of external factors that influence the formation of consumer choice, as proved later. In general, the behavior of individuals is considered quite generalized, the main factors that affect it are the price of the product and budget constraints, personal preferences and the influence of external factors are virtually unknown.

The imperfection of neoclassical theory has led to the emergence of a new direction in the study of economic behavior and consumer choice - behavioral economics, which is the result of the combination of the achievements of economic science, psychology, sociology and cognitive science. The new trend was not accepted by most of researchers of that time, because it completely contradicted the canons of the economic mainstream.

Behavioral scientists believe that consumers are predominantly irrational subjects, which is constantly manifested in their economic behavior. H. Simon, who proposed the theory of bounded rationality, laid the basis for research in this direction. According to this theory, in the minds of every consumer there is a certain "level of requirements" or a bar, which is a conditional standard and with which he compares every possible option. To make a decision, only an idea of the location of the goods relative to the "bar" is sufficient [2]. Simon was the first who pointed out that economic entities seek to satisfy desire, not maximize utility. That is, most individuals will stop by finding an option that satisfies their desires and will not continue to search for the most useful option.

Significant contribution to the development of the direction was made by D. Kahneman and A. Tversky.

Scientists have developed a theory of perspectives that has greatly expanded understanding of consumer choice and decision-making. According to the theory of prospects, the choice depends on the initial conditions, consumers often try to avoid costs instead of receiving greater benefits and are prone to distortions of probability [4]. The Prospect Theory is a continuation of research in economic theory of choice, which includes the use of psychology in economic science. In it, D. Kahneman and A. Tversky rely on 4 basic properties of risk assessment processes that are characterize individuals when choosing between alternatives:

- Dependency on the initial state - shows that the value of all future "winnings" and "losses" is estimated relative to the starting point.

- Loss avoidance - proves that people are more afraid of negative changes in their own wealth than wanting positive ones. For example, the experience of losing a certain amount of money seems more significant than the experience of receiving or winning the same amount.

- Decreasing sensitivity - indicates that the marginal value of wins and losses decreases as their size increases.

- Probability distortion - it is common for people to give incorrect estimation of probability of occurrence of certain phenomena in conditions of uncertainty and risk [4].

The theory of perspectives explains the large number of behavioral phenomena that have been identified through research and cannot be substantiated within the framework of standard theories. The theory has been based on years of research into heuristics - individual judgments and deviations from the standard adopted in economic theory.

D. Kahneman and A. Tversky completely denied the accepted model of classical economic theory Homo economicus - a creature of rational and hyperreflective, which is not only endowed with the ability to order benefits, phenomenal memory and other positive qualities of "machine for consumption", but also such, unable to act "by suggestion" [14]. In practice, people behave differently, guided not by rational but intuitive considerations, as defined by D. Kahneman and A. Tversky as "behavioral heuristics." Therefore, the main conclusion of this theory is that in the decision-making process, individuals tend to repel the risk of a potential loss than for a potential gain. Such a feature can be successfully used in practice as one of the levers of influence on consumer choice.

The laureate of the Nobel Prize in Economics in 2017 is once again a representative of behavioral direction - R. Thaler, who was awarded "for his contribution to the behavioral economics". His main area of research is behavioral finance.

An American scientist argues that a person is not endowed with the ability to act reasonably (rationally) when making an economic decision. Particular attention in studies of Thaler pays attention to motives that induce a person to choose one of the alternatives what he calls nudge [6].

An important contribution of R. Thaler is not only the development of behavioral economic theory, but also the study of the application of his "impulses" studied in various fields: the real estate market, insurance, reform, etc. In addition, R. Thaler used behavioral factors for more global phenomena. For example, a scientist considered the possibility of avoiding the economic crisis of 2008 through the influence of properly applied "shocks" [15].

D. Ariely also explored the problems of irrational behavior and consumer choice. Applying the experimental method, the scientist examined the actual behavior of people in the market and compared their behavior with how they would behave if they were completely rational. The subject of his research has been such everyday situations and actions such as the purchase of goods and refusal, savings and waste, ordering food in restaurants, savings, dishonesty and decision-making under the influence of various emotional states, etc. Modern behavioral scientists' works are characterized mainly by descriptive nature, lack of complex scientific terminology, case studies. That is, teaching becomes more accessible to non-scientific community, and there is popularization of direction.

Behavioral economists have been able to "softly" abandon the model of "economic man" in favor of studying the real economic behavior of individuals. Realism and an interdisciplinary approach allowed to implement the revealed deviations from rational behavior (behavioral errors, biases, inclinations, social effects, frames) to the modern economic theory. Behavioral economists do not stop at the stage of ascertaining the facts of irrational economic behavior, which is widely represented in the writings of predecessors.

They attempt to fruitfully use the deviations found in order to predict the future actions of individuals, to search for incentives for economic behavior, to introduce specific measures of economic impetus (so- called libertarian paternalism) to actions in which individuals themselves are interested. The recurrent consequences of individual actions have been identified, which in turn systematically influence individuals' decisionmaking and performance in the market. Therefore, the influence of cognitive, social, psychological, emotional factors on the process of choice and decision-making is not only stated, but also actively used for directing the activity of economic entities.

On the other hand, the works of behavioral economists end the era of rational economic subject, undermining the foundations of the dominant neoclassical paradigm. After all, not only the "protective belt" is modified, but also the key elements of the "hard core" of the neoclassic, in particular the model of rational choice and stability of individual preferences. Full rationality usually involved a mechanistic consideration of the maximizing behavior of the economic entity on the basis of an orderly endogenous set of sustainable benefits. That is why this premise was and remains the most vulnerable element of the "hard core" of the neoclassical research program.

Proponents of behavioral economics have drawn attention to factors that were not taken into account when studying consumer choices: culture, society, traditions, religion, stereotypes, imitation, behavior of other consumers, individual interests and preferences, etc. Comparing behavioral and neoclassical approaches, scientists argue that behavioral economics is a direction that is fundamentally different from the neoclassical one. However, if one compares the behavioral trend separately with the ordinal approach and the cardinal approach, one can see both differences and some similarities. This comparison is presented in table 1.

Table 1. Comparison of cardinal, ordinal and behavioral approach