The founder of psychological (behavioral) economic theory, winner of the 2002 Nobel Prize in Economics “for the application of psychological methods in economic science, especially in the study of judgment and decision-making under uncertainty” Daniel Kahneman (University of California, Berkeley, PhD in psychology).
Although Kahneman is a psychologist by training and profession, his awarding of the Nobel Prize in Economics in 2002 was welcomed by economists who recognize the great importance of his work for economic science.
The main object of Kahneman’s research is the mechanisms of human decision-making under uncertainty. He proved that decisions made by people deviate significantly from what is prescribed by the standard economic model of homo oeconomicus. Criticism of the “economic man” model had been carried out before Kahneman (for example, Nobel laureates Herbert Simon and Maurice Allee), but it was he and his colleagues who first began to systematically study the psychology of decision making.
In 1979, the famous article “Prospect Theory: An Analysis of Decision Making Under Risk” was published, written by Kahneman in collaboration with Professor of Psychology Amos Tversky (Jerusalem and Stanford Universities). The authors of this article, which laid the foundation for the so-called behavioral economics, presented the results of a huge number of experiments in which people were asked to choose between different alternatives. These experiments proved that people cannot rationally assess either the magnitude of expected gains or losses or their probabilities.
First, it turned out that people react differently to equivalent situations (in terms of the ratio of benefits and losses) depending on whether they lose or gain. This phenomenon is called an asymmetric response to a change in wealth. A person is afraid of loss, i.e., his or her feelings about losses and gains are asymmetrical: the degree of satisfaction from gaining, for example, $100 is much lower than the degree of frustration from losing the same amount. Therefore, people are willing to take risks to avoid losses, but are not inclined to take risks to gain.
Secondly, experiments have shown that people tend to make mistakes when assessing probability: they underestimate the probability of events that are likely to happen and overestimate much less likely events. Scientists have discovered an interesting pattern: even math students who are well versed in probability theory do not use their knowledge in real-life situations, but rather rely on stereotypes, prejudices, and emotions.
Instead of decision-making theories based on probability theory, D. Kahneman and A. Tversky proposed a new theory – prospect theory. According to this theory, a normal person is not able to correctly evaluate future benefits in absolute terms; in fact, he or she evaluates them in comparison with some generally accepted standard, seeking primarily to avoid worsening his or her situation.