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Thaler's Nobel reflects how behavioral economics is in vogue

Richard Thaler won the Nobel Prize for behavioral economics, a branch of economics rooted in psychology, which has gained tremendous cachet
BY Uttara Choudhury |   11-10-2017
Professor Richard Thaler, who teaches at the University of Chicago’s Booth School of Business has won this year's Nobel Prize in Economics
Professor Richard Thaler, who teaches at the University of Chicago’s Booth School of Business has
won this year’s Nobel Prize in Economics

Professor Richard H. Thaler, who teaches at the Booth School of Business at the University of Chicago, asked his MBA class what they would do if they were $5,000 in debt on their credit card, which charges astronomical interest, but they had five grand in their low-interest checking account.

No brainer, right? Pay off the credit card debt in one fell swoop and save money. But few people actually do that. Thaler, who was awarded the 2017 Nobel Prize in Economic Science, on Monday, explained why to his students by exploring the consequences of “limited rationality”.

It’s common for people to ‘compartmentalize’ their money. In particular, they divide their resources into cash for day-to-day expenses and money that should be squirreled away for contingencies. Even though paying off the credit card bill would save money, most people choose to carry the balance to the next month to maintain a buffer in their checking account. Renowned for his use of data to observe and predict how people behave in the real world, that accounting insight is just one of many that has come from Thaler’s work that has now fetched him Nobel recognition.

“Thaler developed the theory of mental accounting, explaining how people simplify financial decision-making by creating separate accounts in their minds, focusing on the narrow impact of each individual decision rather than its overall effect,” noted the Royal Swedish Academy, while bestowing the $1.1 million Nobel on Thaler for his contributions to behavioural economics.

The academy’s citation for Thaler said he has shown how “aversion to losses can explain why people value the same item more highly when they own it than when they don’t, a phenomenon called the endowment effect.” Thaler was one of the founders of the field of behavioural finance, which studies how “cognitive limitations influence financial markets.”

The academy said Thaler’s research had harnessed psychologically realistic assumptions in analyses of economic decision-making, exploring the consequences of limited rationality, social preferences, and lack of self-control.

Thaler is already something of a minor celebrity. He brought to prominence the idea of “nudge” economics, where humans are subtly guided toward beneficial behaviors without heavy-handed compulsion. It was the central theme of his 2008 bestseller Nudge: Improving Decisions about Health, Wealth, and Happiness which he co-wrote with Cass Sunstein, a lawyer at Harvard Law School in Cambridge. It caught the eye of policymakers around the world.

In 2016, Prime Minister Narendra Modi got a surprise endorsement for his controversial demonetization policy from Thaler, who tweeted, “This is a policy I have long supported. First step toward cashless and good start on reducing corruption.”

Behavioral economics is a popular college course

There’s been an explosion of demand from government and industry to hire trained behavioral economists. To meet this demand, Carnegie Mellon University created the first undergraduate major in behavioral economics. Carnegie Mellon’s degree in behavioral economics, policy and organizations (BEPO) trains students to apply psychological insights to human behavior to explain and predict economic decision-making.

In the past decade, this new set of ideas about economic behavior has gone from the margins of academia to the heart of US universities. Behavioral economists teach at Stanford, Berkeley, Chicago, Columbia, Princeton, and MIT. The subfield’s greatest concentration of scholars is arguably at Harvard.

“Harvard’s approach to economics has traditionally been somewhat more worldly and empirical than that of other universities. And if you are worldly and empirical, you are drawn to behavioral approaches,” former US treasury secretary Lawrence H. Summers, told Harvard Magazine which is the independently edited Harvard alumni magazine.

Summers earned his own Economics doctorate at Harvard and identifies as a behavioral economist. He teaches at Harvard’s Kennedy School, and focuses on the implications of changes in the global economy for public policy.

Degree programs specifically on behavioral economics like the one offered by Carnegie Mellon University are rare, but many doctorate programs in economics offer relevant coursework. Behavioral economics is a very popular elective in most business schools. Every year there’s a bidding war among MBA students at schools like Stanford, Columbia and Wharton to get a prized spot on this program.

Thaler is not the first scholar honored by the Nobel Committee for integrating psychology and economics. Daniel Kahneman, a psychologist at Princeton University, won a share of the 2002 prize for his work with Amos Tversky, developing the behavioral foundations of economics.


Uttara Choudhury is a writer for Forbes India and The Wire. In 1997, she went on the British Chevening Scholarship to study Journalism in the University of Westminster, in London. 
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