ABSTRACT
To gain a proper understanding of behavioral economics, we need to understand what came before. This chapter explores the assumptions and principles of neoclassical economics (today’s mainstream view of economics), and its very definite view of rational human behavior, exemplified by homo economicus or ECON: rational individuals with consistent preferences, making choices that serve to maximize their well-being (utility), given their budget constraints. Similarly, firms are said to seek to maximize profits. The rather abstract homo economicus (ECON) depicted in neoclassical economics is characterized, among other things, by great mathematical skills, access to relevant, full information and self-interest. However, these simplifying assumptions of human behavior do not adequately reflect everyday economic life – as experiments and field studies show, people are often altruistic and their preferences often depend on the context. Tversky and Kahneman, in particular, published highly influential research which described how humans (in stark contrast to homo economicus) are affected by biases. They proposed that we use mental shortcuts – something they called ‘heuristics’ – when making judgements. The neoclassical economic approach, therefore, seems in need of modification to include newer empirical findings and a more psychologically realistic understanding of them.
