Psychologist Daniel Kahneman who is one of the godfathers of behavioral economics, won the Nobel Prize in Economics.

New York – Behavioral economics, a branch of economics rooted in psychology has gained tremendous cache in recent decades. It has spawned a growing list of best-sellers such as Malcolm Gladwell’s Blink, Richard Thaler and Cass Sunstein’s Nudge, and Dan Ariely’s Predictably Irrational. It’s not just the success of the books; behavioral economics is one of the trendiest courses in universities across the globe.

Unlike neoclassical economists, behavioral economists don’t see people as “rational actors” coolly weighing costs and benefits. Instead, behaviorists argue that people rely on “a set of instincts, biases, and cognitive shortcuts to make decisions.” A definition of behavioral economics — I've borrowed this one from the Guardian — is that it is the study of "how people actually make decisions rather than how the classic economic models say they make them."

Behavioral economics often focuses on irrational choices, such as why we procrastinate, buy, borrow, and grab chocolate on the spur of the moment.

Behavioral economics and its related area of study— behavioral finance — weigh social, cognitive and emotional factors in understanding why we save too little and spend too much, avoid smart risks and take dumb ones. It studies how emotions affect individual economic decisions and the behavior of markets.

The Godfathers of Behavioral Economics

Behavioral economics and its related area of study— behavioral finance — weigh social, cognitive and emotional factors in understanding why we save too little and spend too much, avoid smart risks and take dumb ones.

It comes as a surprise to most people that two non-economists have won the Nobel Prizes in economics. Herbert Simon of Carnegie Mellon University first put forward the concept of “bounded rationality,” arguing that rational thought alone did not explain human decision-making. When he won the Nobel in 1978 many economists were long faced.

Then in 2002, one of the godfathers of behavioral economics, psychologist Daniel Kahneman, won the Nobel Prize in Economics. Kahneman and Amos Tversky wrote “Prospect theory: An Analysis of Decision under Risk” a seminal paper that used cognitive psychology to explain various divergences of economic decision-making from neo-classical theory.

“Behavioral economics was influenced by psychology from its inception — or perhaps more accurately, behavioral economists made friends with psychologists, taught them some economics and learned some psychology from them. The little economics I know I learned from Dick Thaler when we worked together 25 years ago,” Kahneman told the first “Master Class” convened by Edge in Napa, California, in which he taught a 9-hour program called: "A Short Course on Thinking about Thinking." The attendees were a “who’s who” from business.

“It is somewhat embarrassing for a psychologist to admit that there is an asymmetry between the two disciplines: I cannot imagine a psychologist who could be counted as a good economist without formal training in that discipline, but it seems to be easier for economists to be good psychologists,” quipped the Nobel Laureate.

A Trendy Economic Theory

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, MIT and the subfield’s greatest concentration of scholars is arguably at Harvard.

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, MIT and 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,” Clinton 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 himself 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 are rare, but many doctorate programs in economics offer relevant coursework. Behavioral economics is also a very popular elective for MBA students.

“I have taken behavioral economics as an elective in the fourth term of my MBA program in Columbia. There is a big bidding war to get a prized spot on this program. It is a very popular course,” said Sachin Joshi, founder of business intelligence software outsourcing company Sapience LLC, who is getting a joint MBA degree from Berkley and Columbia University.

“It helps me understand how my customers make buying decisions. Micro economics tells you how rational people will make decisions but people are not rational. There are a lot of emotional reasons for taking a decision. Mob psychology and behavioral components play a part. At an organizational level a lot of purchasing decisions can be explained by behavioral economics,” added Joshi.

Harvard has a popular set of courses on behavioral and experimental economics. It teaches an overview course on behavioral economics and a course on behavioral finance. Behavioral and experimental concepts infuse many other field courses, from development economics to public finance.