Economics long assumed a self-interested agent capable of rational decisions, and judged choices against the expected outcome for total wealth. Kahneman and Tversky kept finding people doing something else in the laboratory, consistently enough that the pattern was not noise. The Nobel committee describes what they found, and it starts with what people compare against.
A reference point, usually where you already are. Individuals turn out to be far more sensitive to how an outcome deviates from that level than to the absolute outcome. Most people are more averse to losses relative to it than they are partial to gains of the same size. Faced with a sequence of risky decisions, they judge each one by its own gains and losses rather than by what it does to their wealth overall.
The tradition being revised is specific. Much economic research relied on a homo oeconomicus motivated by self-interest and capable of rational decision-making, and economics was widely considered a non-experimental science that watched real economies rather than running controlled trials. Kahneman integrated insights from psychology into that, laying the foundation for a new field.
His work on judgment came first in the committee’s account. People in uncertain situations often use rules of thumb that systematically contradict fundamental propositions of probability theory. is one. Asked to classify a man described as interested in politics and debate, most subjects called him a member of parliament rather than a salesman, ignoring how much commoner salespeople are. They went on ignoring it after being told the proportions had been altered substantially.
The more influential contribution concerns decision-making under uncertainty, and it has two parts. Individuals are much more sensitive to how an outcome deviates from a , often the status quo, than to the absolute outcome. And most individuals seem more averse to losses relative to that level than partial to gains of the same size. Facing a sequence of risky decisions, they treat each one by its own gains and losses rather than by its consequences for their wealth as a whole.
Then came the replacement. Kahneman and Tversky developed to explain the observations. The committee lists what it accounts for. Signing up for costly small-scale insurance on appliances. Driving many miles for a few dollars off a small purchase while not bothering to save the same sum on an expensive one. Resisting a cut in consumption after bad news about lifetime income. Insights from psychology have since had a strong effect on financial economics, where applies them to how markets function.
wat. You do not price the outcome. You price the distance from where you were standing, and losses measure longer than gains.
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It is not a quirk around the edges. These results contradict the predictions of expected-utility maximization, which is the machinery much of economics was built on.
How do we know?
The Royal Swedish Academy of Sciences explanation of the two thousand and two prize in economic sciences, awarded to Daniel Kahneman for integrating insights from psychological research into economic science.
What is still unknown
A prize explanation written for the public. It states the findings and what they contradict without the experiments, the coefficients or the debate over how far the laboratory results carry into markets.
Learn something?
Where to next
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