Philosophical Problems of Behavioural Economics The goal of behavioural economics is to improve the explanatory and predictive power of economics This can be achieved by using theoretical and methodological resources of psychology Philosophical Problems of Behavioural Economics argues that behavioural economics is best understood as an attempt to deidealise economic theory guided by psychological research Behavioural economics enriches the model of decision-making by adding different elements Based on this understanding behavioural economics has a number of tasks: first, it has to identify which economic theory needs to be challenged; second, it aims to identify factors which need to be modelled within economic theories of choice and modify the theory accordingly; and finally, it has to create models that explain economic phenomena based on the new theory This book analyses the different stages of this process and shows how the scientific disciplines of economics and psychology are connected by it This volume develops a new account of intertheoretical relations based on the idea of deidealisation and thus contributes to debates within the philosophy of social science It is suitable for those who are interested in or study economic theory and philosophy, economic psychology and philosophy of social science Stefan Heidl is a lecturer and research associate at the Institute for Philosophy, University of Bonn, Germany Routledge INEM advances in economic methodology Series edited by Esther-Mirjam Sent The University of Nijmegen, the Netherlands The field of economic methodology has expanded rapidly during the last few decades This expansion has occurred in part because of changes within the discipline of economics, in part because of changes in the prevailing philosophical conception of scientific knowledge, and also because of various transformations within the wider society Research in economic methodology now reflects not only developments in contemporary economic 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contributions to the methodological literature Foundations of Economic Method, 2nd Edition A Popperian perspective Lawrence A Boland Applied Economics and the Critical Realist Critique Edited by Paul Downward 10 11 12 13 Dewey, Pragmatism and Economic Methodology Edited by Elias L Khalil How Economists Model the World into Numbers Marcel Boumans McCloskey’s Rhetoric Discourse ethics in economics Benjamin Balak The Foundations of Paul Samuelson’s Revealed Preference Theory A study by the method of rational reconstruction, revised edition Stanley Wong Economics and the Mind Edited by Barbara Montero and Mark D White Error in Economics Towards a more evidence-based methodology Julian Reiss Popper and Economic Methodology Contemporary challenges Edited by Thomas A Boylan and Paschal F O’Gorman The Invisible Hand in Economics How economists explain unintended social consequences N Emrah Aydinonat Representation and Structure The methodology of econometric models of the consumption function Hsiang-Ke Chao Reassessing the Paradigm of Economics Bringing positive economics back into the normative framework Valeria Mosini The End of Value-Free Economics Hilary Putnam and Vivian Walsh 14 15 Economics for Real Aki Lehtinen, Jaako Kuorikoski and Petri Ylikoski Philosophical Problems of Behavioural Economics Stefan Heidl Philosophical Problems of Behavioural Economics Stefan Heidl First published 2016 by Routledge Park Square, Milton Park, Abingdon, Oxon OX14 4RN and by Routledge 711 Third Avenue, New York, NY 10017 Routledge is an imprint of the Taylor & Francis Group, an informa business © 2016 Stefan Heidl The right of Stefan Heidl to be identified as author of this work has been asserted by him in accordance with sections 77 and 78 of the Copyright, Designs and Patents Act 1988 All rights reserved No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers Trademark notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging in Publication Data Names: Heidl, Stefan, author Title: Philosophical problems of behavioural economics / Stefan Heidl Description: Abingdon, Oxon ; New York, NY : Routledge, 2016 | Includes bibliographical references and index Identifiers: LCCN 2015047387 | ISBN 9781138639195 (hardback) | ISBN 9781315637372 (ebook) Subjects: LCSH: Economics—Psychological aspects—Philosophy | Economics—Philosophy Classification: LCC HB74.P8 H45 2016 | DDC 330.01/9—dc23LC record available at http://lccn.loc.gov/2015047387 ISBN: 978-1-138-63919-5 (hbk) ISBN: 978-1-315-63737-2 (ebk) Typeset in Times New Roman by FiSH Books Ltd, Enfield Contents List of tables Acknowledgements x xi The ontological status of economic preferences 2.1 Behaviouristic versus mentalistic interpretations of preferences 26 2.2 The behaviouristic interpretation of preferences 29 2.2.1 Two methodological arguments against the behaviouristic preference concept 30 2.3 The mentalistic interpretation of preferences 34 2.3.1 Deidealising economic theory based on psychological insights 36 2.3.2 Testing hypotheses about mentalistic preferences 38 2.4 Conclusions 43 26 Introduction 1.1 Introduction and motivation 1 1.2 Behavioural economics 2 1.2.1 Models of economic agents 3 1.2.2 Behavioural decision research 6 1.3 Intertheoretic relations 10 1.3.1 Theory reduction 10 1.3.2 Non-reductive intertheoretic relations 16 1.4 An idealisation-based account 17 1.4.1 Philosophical accounts of idealisation 17 1.4.2 Deidealising economic theory 19 1.5 Summary of the following chapters 20 viii Contents Selectionist arguments against a deidealisation of economics 3.1 Selection processes as the object of economic theory 48 3.2 The limits of the selectionist interpretation 50 3.3 Conclusions 53 48 Aggregation and the deidealisation of economic theory 55 4.1 Correction as a goal of intertheoretic relations 55 4.2 Investigating the scope of standard economic theory with model-based strategies 57 4.2.1 A model of random choice 57 4.2.2 The effect of small deviations from rationality 59 4.2.3 Determining the influence of rational agents 60 4.3 Experimental investigations of the scope of standard economic theory 62 4.3.1 Measuring the market-level effect of individual-level biases 63 4.3.2 The effect of heterogeneity of the population of agents 65 4.4 A comparison of model-based and experimental methods 67 4.5 Conclusions 69 Explanatory autonomy and intertheoretic relations 71 5.1 The idea of an explanatorily independent discipline 71 5.2 The economic aspect of the world 72 5.3 The explanatory independence of economics 73 5.3.1 Psychological presuppositions of economic theory 75 5.4 Arguing about the scope of economic theory 77 5.4.1 Questioning the normative correctness of the standard theory 78 5.4.2 Restricting the scope of economic theory 83 5.4.3 Extending the scope of economics 85 5.4.4 A theory-based understanding of the scope of economic theory 86 5.5 Conclusions 87 Localising anomalies of economic theory 6.1 Disconfirming single hypotheses 90 6.1.1 Holism 91 6.1.2 Underdetermination and experimental control 92 90 Contents ix 6.2 Isolating critical assumptions of economic theory 94 6.2.1 Cooperation in the ultimatum game 94 6.2.2 Testing hypotheses about cooperative behaviour 97 6.3 The role of psychology in isolating critical assumptions 99 6.4 Conclusions 103 The structure of behavioural economic theories 7.1 Behavioural economic theories as deidealisations 106 7.2 Examples of behavioural economic theories 106 7.2.1 Loss aversion 107 7.2.2 Inequity-aversion 109 7.3 The testability of behavioural economic theories 111 7.3.1 The parameterisation of behavioural economic theories 112 7.3.2 Reference point determination 113 7.4 Limitations of the deidealisation approach 114 7.4.1 Theories of cognitive processes as an alternative to the deidealisation approach 117 7.4.2 Market-level consequences of individual choice behaviour 119 7.4.3 Iterative improvements of economic theory 121 7.5 Conclusions 124 106 Models in economics: standard and behavioural 8.1 Models of economic systems and theories of choice 128 8.2 The explanatory power of economic models 130 8.3 The realism of behavioural economic models 134 8.4 The refutation of behavioural economic models by standard economic models 139 8.4.1 Refining the explanandum 141 8.4.2 The unificationist power of behavioural economic theory 144 8.5 Conclusions 146 128 Index 157 Conclusion 9.1 Summary of the previous chapters 149 9.2 Main results 152 149 150 Conclusion preferences from which the standard theory abstracts is feasible because the economic theory of choice should be interpreted as a theory of deliberation Chapter argued that behavioural economics also has the function to work out under which circumstances standard economic theory needs to be deidealised With both model-based and experimental strategies behavioural economists can explore the domain within which idealisations of economic theory can be employed This allows one to understand whether factors that influence individual choice behaviour from which the standard theory abstracts need to be introduced to understand the behaviour of markets Even though behavioural economists can learn through these strategies whether in a specific market standard economic theory will be applicable, they face the problem of how to extrapolate these results.1 The results about the applicability of the standard theory are specific to the market of the model or the experiment, so that it is hard to say if the theory will also be applicable in different situations that are only similar in some aspects to the model or the experiment Chapter is about the relation of explanatory autonomy and intertheoretic relations I have shown that explanatory autonomy is an important feature of the special sciences because it aids the understanding of complex phenomena, but that it cannot be used to argue for a complete independence of a special science Furthermore, I analysed whether it is possible to argue against a deidealisation of economic theory by restricting the scope of the theory Behavioural economists argue that a restriction of the scope would mean that many phenomena that are traditionally understood as economic can no longer be explained by economic theory If economics only applies to situations in which people have repeated experiments with the choice-problem they are facing, the scope of economic theory becomes small Behavioural economists want to deidealise economic theory to extend its scope In addition, they argue that by modelling influences from which the standard theory abstracts one better understands the scope of the standard economic theory I also discuss whether the status of the standard theory as normatively correct means that one can expect that people will act according to the theory when they are given opportunity to learn When one accepts the normative correctness of the standard theory one can argue that behavioural economic theory is still necessary to explain the behaviour of people who did not have enough time to learn So the fact that people might learn to correct their mistakes cannot show that is unnecessary to deidealise economic theory Furthermore, it is even possible to question the normative correctness of the standard theory Behavioural economic theories can be considered Conclusion 151 normatively correct This means on the one hand that there is no reason to suspect that, given time for learning, people will act as predicted by the standard theory because the behaviour of people is not mistaken On the other hand, it means that one needs to reconsider how normative theories of choice are justified The practice of behavioural economics might suggest that normative correctness of theories of reasoning is pragmatically justified by their success in guiding the behaviour of agents.2 In Chapter I described the strategies behavioural economists employ to isolate critical assumptions of economic theory as the sources of anomalies The idealised standard theory fails to be predictively correct in certain domains If one wants the theory to apply to situations within these domains, one needs to deidealise it by modelling influences from which it abstracts This requires one to identify which assumption of the theory causes it to be predictively incorrect Behavioural economists employ experimental strategies to identify the assumptions that are responsible for the predictive failures of the standard theory They also use experimental methods to test by which alternative assumptions these assumptions need to be replaced Psychological theories sometimes suggest which factors might be responsible for anomalies of the theory The methods behavioural economists employ are ways of dealing with the underdetermination of theory by data and they show what the truth in confirmatory holism is: different hypotheses of a theory are tested jointly, but this does not mean that evidence cannot refute a single hypothesis By carefully designed experiments, behavioural economists can identify a single hypothesis as the sources of an anomaly In Chapter I described the structure of behavioural economic theories that are typical of what I call the deidealisation approach These are theories that extend the standard theory by modelling the influences that have been identified as the cause of the predictive failure of the standard theory A problem of these theories is related to the fact that they have been created based on the type of experimental studies presented in Chapter They might have been created to merely accommodate the experimental results To avoid this problem, behavioural economists emphasise the importance of novel predictions and of a proper theory of reference point determination This removes degrees of freedoms because the reference point cannot be adjusted to a data and thereby makes it harder to merely fit the overall theory to a data set If a theory is predictively correct despite these restrictions, the prediction counts as a proper confirmation of the theory Such theories are furthermore criticised for being insufficiently based on psychological insights about the decision-making process I suggest that dynamic reasoning models of decision process are an important complement to the theories based on the deidealisation approach, but that 152 Conclusion for the goal of explaining the behaviour of economic systems the deidealised theories fulfil an important role By using deidealised economic theories one can employ standard economic methods to develop aggregatelevel consequences out of the theories’ assumptions about individual choice behaviour The dynamic reasoning models are complementary because they allow us to understand when to apply a specific deidealised theory Additionally, the use the deidealisation approach offers the possibility of an iterative improvement of economic theory in which the localisation of anomalies of theories and the subsequent modification of the theory is repeated The iterated process of testing old theories of choice and creating new theories that can be tested again offers a possibility of improving economic theory In Chapter I showed how behavioural economic theories can be used to construct models that explain aggregate-level economic phenomena Behavioural economic models cannot avoid problems standard economic models have with the realism of their assumptions They are ‘overconstrained’ in a similar way as standard economic models and thereby only allow us to abductively infer the causes of economic phenomena This is the case because just like standard economic models they need to employ very specific assumptions to derive aggregate-level results Therefore they can only make it plausible that a real world phenomenon is created in the same way as a similar phenomenon within the world of the model Related to this point, behavioural economic models face the problem that phenomena that can be potentially explained by a behavioural economic model can also be explained by standard economic models One way in which behavioural economists deal with this objection is that they specify the phenomena that is to be explained in a more fine-grained way, so that the new explanandum can only be explained by the behavioural economic model A second strategy is to argue that the behavioural economic explanations cannot only explain the phenomenon of the interest but also other phenomena in a unified way There exist standard economic explanations for all these phenomena but each of them needs different ad hoc assumptions that are not well justified and sometimes even contradictory This shows that behavioural economic explanations are at least often more plausible than standard economic explanations 9.2 Main results The result of behavioural economic research is not a new type of economic theory that is a combination of economic theory and psychological theory Conclusion 153 Neither is it an economic theory that is derived from psychological theory Instead, behavioural economic theories are best understood as deidealised versions of standard economic theories Correspondingly the goal of behavioural economists is to learn when it is necessary to deidealise economic theory and how to deidealise it Psychology aids the process of deidealisation Principles of the psychology of perception can be used to identify factors that might influence choice behaviour Alternatively, after an anomaly of the standard theory has been found, psychology might suggest mechanisms that are responsible for the occurrence of the anomaly The reactions to behavioural economics by standard economists show the diversity of strategies of defending a theory against empirical criticism There are strategies of reinterpretation that change the object of the theory to defend it against empirical criticism In the case of economic theory, these strategies fail because they not adequately capture the actual use of the theory in explanations The acceptance of the behaviouristic interpretation would needlessly impoverish the explanatory practice of economics It is also motivated by worries about the empirical content of economic theory that are shown to be unfounded Connecting the methodological debate about the interpretation of preferences with the philosophical debate on confirmation theory shows how to remove the worry about the empirical content of the theory The selectionist reinterpretation fails as a defence of the standard theory against empirical criticisms because it is just not feasible to take selection processes as the object of standard economic theory Nevertheless, if offers an interesting perspective on the possibility of an evolutionary grounded economics.3 Replacing the foundation of the standard theory while trying to keep all of its results is impossible, but it is a genuine possibility to create a new type of economic theory based on selectionist foundations The discussion of the relevance of individual-level deviations from the theory for the aggregate level illustrates a general strategy of behavioural economists This strategy is to take the informal arguments proposed as a defence against modifications of the standard theory and turn them into testable claims Explorations of these defensive claims can be turned into explorations of the scope of the standard theory By formalising these arguments it becomes clearer in which range the standard theory actually does not need to be modified By this method behavioural economists attain a classical goal of intertheoretic relations They can learn under which circumstances the standard theory is predictively correct This method shows that problems that physicists might solve with the help of a general theory, economists have to solve with the help of more local model-based and experimental strategies These strategies have 154 Conclusion characteristic limitations This theme appears in both Chapters and In both cases the question is how to extrapolate results that have been gained by the study of a model, an experiment or a simulation to a system of interest that we cannot study directly In Chapter this is shown by the fact that we can learn about the applicability of the standard theory only for very special circumstances and not know how the theory will fare under similar but different circumstances In Chapter the problem of extrapolation also shows up: when we observe within a model a mechanism that generates a certain phenomenon, we cannot be sure that the same phenomena in other settings is generated by the same mechanism Explanatory autonomy, which is also proposed to immunise economic theory against empirical criticism, is important for cognitive reasons and issues of understanding But it should not be used to argue against intertheoretic relations and the unity of science In contrast, explanatory autonomy even requires the unity of science to decide on the applicability of autonomous explanations Causal complexity means that there are many different influences on a single phenomenon Explanatory autonomy of the special sciences is important because it means that despite this causal complexity we can formulate explanations that explain a phenomenon as a result of a single causal influence.4 The advantage of such explanations is the clear understanding they offer The possibility of offering such explanations does not mean that special sciences that offer such independent explanations are completely independent The possibility of formulating independent explanations despite the causal complexity requires evidence from other disciplines that certain influences are absent, because otherwise independent explanations will fail.5 Chapters and show that how theories are modified depends on our explanatory interests and the purpose of the theory To understand the practice of behavioural economics one needs to keep in mind that behavioural economists are not primarily interested in improving the theory of individual choice for its own sake, but rather with the goal of explaining the behaviour of markets This means that one has to explore how individual behaviour is mediated into aggregate behaviour This is shown in Chapter To argue for a modification of the economic theory of choice requires that one shows that this improves the ability of the theory to predict market-level phenomena Second, it also influences the form of the resulting theories, as is shown in Chapter Behavioural economists not employ process theories of individual choice because based on these theories it is hard to predict the behaviour of markets But sometimes economists also want to understand why certain features of individual behaviour arise Such empirically based Conclusion 155 models of choice process are useful for economists who deal with strategic interactions in which only a few agents interact Even economists who are interested in features of markets might be interested in these models because it might allow them to understand when the (quasi-)optimisation models of the deidealisation approach might be applicable Another important element of behavioural economic practice found in Chapter is that behavioural economists aim at iterative improvements of economic theory In the case of behavioural economics the creation of intertheoretic relations is characterised by repeated attempts to identify anomalies and remove these anomalies by modification of the theory In these attempts, standard economic theories fulfil an important function as a benchmark or template They can be used as a background for tests This background allows observing effects that otherwise might have been invisible Behavioural tendencies become more visible because they are seen as deviations from the standard theory After such a deviation has been identified, principles of psychology can help to infer what the cause of this specific pattern of deviations is The resulting modified theory can serve again as a benchmark that allows the identification of further behavioural tendencies that need to be integrated in later versions of the theory There is a certain tension inherent to this approach because it uses a template of a theory of choice that is based on abstract principles of rationality while simultaneously trying to integrate psychological factors that belong to theories of actual mental processing It might be possible that the results of further empirical research will lead to a more radical change in the theoretical framework of economics The new framework might no longer employ the template of rational optimisation The iterative strategy of behavioural economics can still be defended as rational because it is a way of keeping as much of the past explanatory successes of economic as possible by changing the theory in the smallest possible way as a reaction to empirical anomalies Finally, the discussion of Chapter shows that behavioural economists are rightly concerned about the realism of assumptions of economics but that their solution to this problem is incomplete The limited explanatory power of economic models is not only caused by the lack of true general principles of individual choice behaviour but also by the specificity of the assumptions of these models As behavioural economists employ the same kind of modelling strategies as standard economists, they nothing to alleviate the worry that economic models cannot teach us much about real economic systems because of the specificity of the auxiliary assumptions that are employed in these models Still, the introduction of behavioural economic theories of choice in these models allows the unified explanation of many phenomena that are anomalous from the perspective of the 156 Conclusion standard theory and it does so without introducing ad hoc assumptions in the way the standard theory needs to This promises that behavioural economics has started a process by which the explanatory and predictive power of economics might improve Notes Cf Steel (2007) on the general problem of extrapolation in social science Cf Sugden and Zamarrón (2006) on pragmatic justification of normative theories of choice Cf Vromen (1995) for a philosophical study of evolutionary approaches in economics Cf Potochnik (2010: 215) Cf Potochnik (2010: 216) References Potochnik, A., 2010 Explanatory Independence and Epistemic Interdependence: A Case Study of the Optimality Approach British Journal for the Philosophy of Science, Volume 61, pp 213–233 Steel, D., 2007 Across the Boundaries New York: Oxford University Press Sugden, R and Zamarrón, I., 2006 Finding the key: The Riddle of Focal Points Journal of Economic Psychology, Volume 27, pp 609–621 Vromen, J., 1995 Economic Evolution: An Enquiry into the Foundations of New Institutional Economics London: Routledge Index abductive inferences 133–4 actions, labelling of 80 actual mental processing 124 advantageous inequality 109 agents see economic agents aggregates 63 Aim and Structure of Physical Theory, The (Duhem) 93 Akerlof, G 130–1 Akerlof, G and Yellen, J 59–60 Alchian, A 50–1, 52 algorithmic level, economic decisionmaking 14, 15, 16 ‘all-things-considered preferences’ 35 anomalies, localising 90–103, 151 Aristotelian idealisation 17, 19 Arrow, K 103–4n2 Asian disease problem assumptions 151; background 132, 134; isolating 132; special 144; unrealistic 132 asymmetric information 131 Bacharach, Michael 38, 45n6 background theory 19 backward induction 95, 96 Baigent, N 35 Becker, G 57, 58, 72–3 behavioural biases 123 behavioural decision research 6–7, 36, 86; as anomalies of economic theory 9–10 behavioural economic agents 60–1 behavioural economics 2–10 behavioural economic theory(ies) 56–7, 60, 144–6; as deidealisations 106; inequity aversion theory 109–11, 113, 119, 120; limitations of deidealisation approach 114–24; loss aversion theory 107–9, 113, 113–14, 135, 141–3; parameterisation of 112–13; reference point determination 113–14; testability of 111–14 behaviouristic interpretations of preferences: identification of outcomes 30–2; identity of choice and preference 32–4; versus mentalistic interpretations 26–9, 29–34; methodological arguments against 30–4 behaviouristic theory of choice 43 Benartzi, S and Thaler, R 134, 135, 136, 137–8 benchmark(s) 123 Berg, N and Gigerenzer, G 115 Bernheim, B.D and Rangel, A 26, 44n1 Binmore, K 26, 83–4, 85 Binmore, K and Shaked, A 112 black-boxing 75 bootstrap account of confirmation 39–41, 90 bootstrapping 41–2 bounded rationality theories 38 Bruni, L and Sugden, R 85 cab drivers 141–3 calibrated models 27 Camerer, C 55, 144 Camerer, C and Loewenstein, G 2, 36 Camerer et al 141, 142, 143 158 Index Caplin, A 39 Cartwright, N 131–2, 134 certificates 63, 64, 66–7 Chang, H 122 chemical theory 83 choice behaviour 8–9, 72, 77, 115; see also individual choice behaviour choice experiment 65–7 choice-governed behaviour 77 choice-problem(s) 76, 85, 100–2, 104n2, 107 choice(s): consumer 3; identity of 32–4; objects of 31; predicting and explaining 30–1; prospect theory 10; reference points dependence of 100; strategic, model of 4–5; theories of 128–30; see also preferences classical genetics 12 cognitive hierarchy theory 125n3 cognitive mechanisms 13, 15 cognitive processes 117–19 cognitive psychology 117 commitment 37, 38 comparative statics, method of 120–1 complementary goods 73–4 completeness 3, computational level, economic decision-making 14 confirmation, bootstrap account of 39–41, 90 confirmation theory 40, 153; and holism 91–2 confirming single hypotheses 90–4 consumer choice(s) 3; economic theory of 100 consumption choices 58 context-dependent choices 117 contrastive underdetermination 140 cooperation 5–6 cooperative behaviour 37, 94–5, 119; testing hypotheses about 97–9 coordination games 80–1 correction 55–7 corrective reduction 55–6 crashes, economic 138 Craver, C and Alexandrova, A 13, 15 Crawford, V 123 credible worlds 130, 132–3, 134 crime, economic theory of 72–3 criminal behaviour 72–3 cue-elicited craving 74 Darden, L 90 Darden, L and Maull, N 16 data: for individual scientific disciplines 28; physiological 27; preference 27 death rates decision-making: multiple stages of 117–18 decision-making under uncertainty 3–4, 115 decision problem(s) 8–9, 76, 78 deductive inference 82 deidealisation(s) 18, 150; of behavioural economic theories 106, 114–24, 151–2; of economic theory 17, 19–20, 36–8, 55–69; of economic theory based on psychological insights 36–8; inequity aversion theory 109–11, 113, 119, 120; justification for approach 123; limitations of approach 114–24; loss aversion theory 107–9, 113, 113–14, 135, 141–3 ; see also idealisation deliberation-based theory 52, 53 delimiting the scope 62, 69 descriptive invariance 8–9 Dictator Game 103n1 disadvantageous inequality 109 disutility of effort 143 Dizadji-Bahmani et al 10–11 DNA 12 Dohmen et al 42 Duhem, P 93 economic agents: behavioural 60–1; consumption choices 58; determining the influence of rational agents 60–2; effect of heterogeneity of 64–7; expected utility theory 3–4; explaining economic phenomena 36; fixed preferences 36; game theory 4–6; individual demands of 58; influencing market behaviour 66–7; mental states of 27, 29, 31, 32, 35; models of 3; perspective interpretation of game theory 31; see also rational agents economic choice behaviour 100 economic consumer theory 85–6 economic crises 138 economic decision theory economic models: explanatory power of 130–4; realism of behavioural 134–9; refutation of behavioural 139–46; and theories of choice 128–30; unificationist power of behavioural economic theory 144–6 economic preferences see preferences economics: distinct from psychology 74; explanatory factors 71; explanatory independence of 73–7; extending the scope of 85–6; improving the explanatory power of 2; instrumental rationality 72; integrating psychology 2; predictive exercise 28–9; see also mechanisms economic systems: models of 128–30 economic theory: anomalies of 9–10; deidealisation of 17, 19–20, 36–8, 55–69; and firms 48–9; individual firms 52; isolating critical assumptions of 94–9; iterative improvements of 121–4; results of selection processes 50; selectionist reinterpretation of 50–1; wages and labour costs 51; see also standard economic theory Elliot, K 122 empirical criticism 153 empirical evidence 82 empirically observed behaviour 139 endowment effect 108 epistemic interdependence 75 epistemic iteration 122 equilibria, salience of 80–1 equilibrium: reflective 82–3 equilibrium analysis 120–1 equity premium puzzle 134–7 evaluation periods 136–7 evaluation processes 27 evidence 91–2; corroboration through 39; empirical 82 expectation formation 39 expected utility theory 3–4, 79; anomalies of 99–102 Index 159 experimental control 92–4 experimentally observed behaviour 37–8 experimental methods 91; comparison with models 67–9 explanandum, refining the 141–4 explanatory autonomy 150, 154; economic aspect of the world 72–3; of economics 73–7; idea of 71–2; scope of economic theory 77–87 explanatory patterns 86 extensionality 81 external validity, problem of 67–8 extrapolation 154 fair outcomes 97 Falk et al 97, 99 fall law 56 false beliefs 116 Fehr, E and Schmidt, K 97, 109, 110–11, 112 firms 48–9; adapted and less-well adapted 51; and competition 52; surviving in a market 52 focal points 80–1 formal logic 82 framing 36 framing effects 62–3, 76–7 frictions 139, 144 Friedman, M 50; on firms’ behaviour 48; on maximisation of returns 49; on unification 145 Frigg, R and Hartmann, S 17, 17–18; deidealisation 19–20 functional reduction 12–13 gain-lost utility 108 Galilean idealisation 18, 19 Galileo 11, 56 gambling behaviour 144 game theory 4–6, 33, 80–1, 103n2; anomalies in 94–6; perspective interpretation of 31 genes 12 Gibbard, A 36 Glymour, C 39, 40, 91; on nongenuine hypothesis tests 40–1 Goodman, Nelson 82 gravitation and motion, laws of 56 Guala, F 38, 92–3, 93, 96, 103n2 160 Index guidance by past experience stage 118 Gul, F and Pesendorfer, W 27–8, 39, 73–4 Güth et al 95, 96 Güth, W 114, 117–18, 119 hardware level, economic decisionmaking 14, 15 Hargreaves Heap, S 139 Harstad, R.M and Selten, R 120, 121 Hartmann, S and Frigg, R 124 Hausman, D 29, 35, 78 Hempel, C 56 holism 91–2 holist underdetermination 140 human choice behaviour 78–9, 100–1 human motivation 149 hypotheses: about cooperative behaviour, testing 97–9; about mental preferences 41–2; corroboration through evidence 39; disconfirming single 90–4; theoretical 39, 40–1 idealisation 17–20, 150; Aristotelian 17, 19; Galilean 18, 19; justification of 18–19; minimalist 18, 19; philosophical accounts of 17–18; psychology, aiding the process of 153; standard economic theory 17–20; see also deidealisation(s) ideal rationality 123 identification of outcomes 30–2 imperfect information 139 implausible assumptions implementation level, economic decision-making 14, 15 incentives 72 individual behaviour, psychological theories of 2–3 individual choice behaviour 36, 53–4, 57, 69n1, 111; market-level consequences of 119–21 individual-level prediction 58–9 inequity-aversion-based explanations 97, 98, 99 inequity aversion theory 109–11, 113, 119, 120 inference(s) 82, 133 informational asymmetry 130–1, 132 inner psychological agent 117 inner rational agent 116, 117 instant feedback 84 instrumental rationality 72, 73, 76, 87 integrated risky choices 135 integration 15 intention-based explanations 97, 98, 99 intention filter 118 intention generator 118 interfield theory 16 Internal Consistency of Choice (Sen) 30 intertemporal choice 115 intertheoretic relations 10–17, 44; correction as a goal of 55–7 Inventing Temperature: Measurement and Scientific Progress (Chang) 122 investor behaviour 135–8 investors 135; attitudes to risk 3; lossaverse 135–6 irrationality 117 iterative improvements 121–4, 152 judgement errors: market traders 66–7 justification, process of 82 Kahneman, D 86, 87 Kahneman, D and Tversky, A 1, 8–9, 36, 78–9, 100–2, 113 Kepler’s laws 56 Kim, J 12 Kluger, B and Wyatt, S 64–6, 66–7 Koszegi, B and Rabin, M 108, 114 labelling 80–1 labour costs 51 law of falling bodies 11 Lewis, David 26 linear utility functions 131 liquidity constraints 142, 143–4 localising anomalies 90–103 Loewenstein, George 85 logic, formal 82 Loomes et al 84–5 Loomes, G and Sugden, R 79–80 loss-averse investors 135–6 loss aversion theory 107–9, 113, 113–14, 135, 141–3 lotteries 4, 7, low-level causal detail 74 Mäki, Uskali 145, 146 marginal utility 141 market behaviour 60 market demand curve 58, 58–9 market experience 63, 84 Market for ’Lemons’ (Akerlof) 130 market-level effect: of individual-level biases 62–4 market-level prediction 59, 66–7 market prices 55, 67 markets: behaviour of 57; financial feedback 63; partition dependence 63–4 Marr, D 14–15, 16 maximisation-of-returns hypothesis 49 maximisation problem 72 maximised profits 52 maximiser firms 52 McMullin, E 17 mechanisms 13–16, 23n1 Medin, D and Bazerman, M 9, 10 Mehra, R and Prescott, E 138 mental accounting, theory of 135 mentalistic interpretations of preferences 35–44, 43–4, 149; advantages of 42–3; versus behaviouristic interpretations 26–9; deidealising economic theory based on psychological insights 36–8; testing hypotheses about 38–44 mentalistic theory of choice 43 mental preferences 41–2 mental processing, actual 124 mental states 27, 29, 31, 32, 35; nonobservable 39 methodological iteration 122 Methodology of Positive Economics, The (Friedman) 48, 50 Mill, John Stuart 140 minimalist idealisation 18, 19 minimal rationality 59 mistaken objects 116 model-based explorations 56–7 models: comparison with experimental methods 67–9 models of dynamic reasoning 118–19 models of economic systems 128–30 molecular biology 12 Index 161 Morgan, M 68 motivation 149 multilevel mechanisms 13 Myopic Loss Aversion and the Equity Premium Puzzle (Benartzi and Thaler) 134 Nagatsu, M 14, 23n2 Nagelian theory 10, 11 narrow framing 135 Nash-Equilibrium 5–6 negative substitution effect 58 neuroeconomics 23n2, 27–8 new behavioural economics see behavioural economics Newton, Sir Isaac 56 ‘New Wave’ account of reduction 11–12 Nickles, T 121–2 non-maximiser firms 52–3 non-reductive intertheoretic relations 16–17 normative correctness 78–83, 150–1 normative theory 81–2 novel predictions 112–13 objects of choice 31 observable choice behaviour 39 ontology 20–1 optimisation problems 115, 116 outcomes 9; fairness of 97, 103n1; identification of 30–2; losses or gains 107; ranking of 107 parallelism 68 parameterisation of behavioural economic theories 112 partition dependence 63–4 patterns, explanatory 86–7 perception: psychology of, general principles of 100; reference point dependent 100 perception, laws of 31 perception, psychology of 77 perceptual information processing 15 permanent underdetermination 140 personal agency 36 phenomena 71, 73, 76, 77, 152 physiological data 27 plausible mechanisms 13 162 Index Plott, C 72, 77–8, 86 populations 13 positive profits 52 Potochnik, A 75 prediction: as goal of economics 28–9; and standard economic theory 56–7 prediction markets 63, 64 preference concept 21 preference data 27 preference reversals 7–8, 109 preferences 149; behaviouristic interpretations of 29–34; behaviouristic versus mentalistic interpretations of 26–9; identity of 32–4; mentalistic interpretations of 35–44; ontological status of 26–44; stability of 76; see also choice(s) price changes 58–9 price formation process 61 prices: complementary goods 74; market 67 prisoner’s dilemma 5–6, 45n6; cooperation in 37–8 probability 63, 64, 65, 66 problem of external validity 67–8 procedural invariance 7–8 process models 121 process-theoretic approach 119 process theories 121 procrastination 36 prospect theory 10, 79, 125n1, 135 Prospect Theory: An Analysis of Decision under Risk (Kahneman and Tversky) 113 psychology: aiding the process of deidealisation 153; behavioural decision research 6–7; distinct from economics 74; integration with economics 2; of perception, general principles of 100, 153; presuppositions of economic theory 75–7; regret and rejoicing 79; role in isolating critical assumptions 99–102; role of 77 pull-back strategy 83 Quine, W V 91 Rabin, M 17, 36, 90, 114, 116, 121; on fairness of outcomes 97 random choice, model of 57–9 rational agents: determining the influence of 60–2; individual choice experiment 65–6; influencing market behaviour 66–7; market version of choice experiment 66–7; see also economic agents Rational Choice and Social Theory (Satz and Ferejohn) 49 rational-choice theory 50 rational decision-making Rational Fools (Sen) 37 rationalisation 139 rationalising models 144, 147n2 rationality 31, 81; small deviations from 59–60 reasoning 31, 78; normative theory of 79 reduction: corrective 55–6; functional 12–13; Nagel 11; ‘New Wave’ account of reduction 11–12 reductionism 91 reduction theory 10–11 reference point dependence of choice 100, 107–8, 108–9 reference point determination 113–14, 151 reference points refining the explanandum 141–4 reflective equilibrium 82–3 refutation by rationalisation 139 refutation strategies 139–46 regret theory 79 representational level, economic decision-making 14, 15, 16 respecification theories 38 responder behaviour, theory of 118 response modes revealed preference theory 29, 32, 39 revisionary theories 38, 45n6 Rietz, T 138 risk: evaluation of risk aversion 135, 138 risky choices 135 Rosenberg, A 32, 34 Ross, D 72, 77 Rubinstein, A 31, 115–16 Russel, T and Thaler, R 60–1 salience 80–1 Samuelson, Paul 28 Satz, D and Ferejohn, J 49, 49–50 Savage, L 103n2 scale compatibility 7–8 Schaffner, K 55 Schelling, T 80–1 scientific research/progress 122 search costs 139 selection-based theory 52, 53, 149–50, 153 selectionism 21 selection processes 153; and economic theory 50; and firms 48–9; limits of 50–3; on markets 49–50, 50 Sen, Amartya 30, 32, 36; on cooperation in the prisoner’s dilemma 37, 38; cooperative behaviour 37 similarity, of models 68 similarity relations 115 single hypotheses 90–4; experimental control 92–4 social behaviour 72; theory of 111 social phenomena 36 solution concept Sonnemann et al 62–3, 64 special assumptions 144 special sciences 74, 87, 154 Spiegler, R 139, 144, 147n2 Spohn, W 82–3 stable tendencies 131–2, 132 standard economic agents 60–1 standard economic model 130 standard economic patterns of explanation 86 standard economics 44n1 standard economic theory 9; delimiting the scope of 62, 69; effect of heterogeneity of the population of agents 64–7; ensuring the market-level effect of individual-level biases 62–4; idealisation-based account 17–20; market-level predictions 51; modelbased strategies 57–62; model of random choice 57–9; normative correctness 78–83; prediction 56–7; psychological presuppositions of 75–7; restricting the scope of 83–5; scope of 77–87; small deviations Index 163 from rationality 59–60; theorybased understanding of the scope of 86–7; see also economic theory; explanatory autonomy standard preference theory 36 standard utility theory 142 Stanford, K 140 stimuli 100 stocks, return on 135 stock trading 84 strategic backward induction 118 strategic choice, models of 4–5 strategic reasoning 80 Strevens, M 18–19, 74–5 Sugden, R 35, 54n1, 104n2; abductive inferences 133–4; behavioural economic theories 112; economic models 132; on inferences 133; on the inner rational agent 117; inner rational agent 116; loss aversion theory 109 Sugden, R and Zamarron, I 81 superficial strategic analysis stage 118 survival rates symmetric information 131 A System of Logic (Mill) 140 taste changes 34 Thaler, R 135 theoretical hypotheses 39, 40–1 theoretical models 133 theories: background theory 19; behavioural economic theory see behavioural economic theory(ies); chemical theory 83; cognitive hierarchy theory 125n3; confirmation theory 40; deliberation-based theory 52; economic theory see economic theory; expected utility theory 3–4, 79; game theory see game theory; inequity aversion theory 109–11, 113, 119, 120; interfield theory 16; loss aversion theory 107–9, 113, 113–14, 135, 141–3; Nagelian theory 10, 11; prospect theory 10, 79, 125n1, 135; rational-choice theory 50; reduction theory 10–11; regret theory 79; revealed preference theory 29, 32, 39; 164 Index selection-based theory 52, 53, 149–50, 153; standard economic theory see standard economic theory; standard preference theory 36; standard utility theory 142 theories of choice 128–30 Theory and Evidence (Glymour) 40, 41 Theory Change in Science (Darden) 90, 106 A Theory of Fairness, Competition, and Cooperation (Fehr and Schmidt) 112 theory reduction 10–11 three-level view, economic decisionmaking 14–15, 16 total comparative evaluations 35–6 transient underdetermination 140 transitivity 3, Tversky, A and Kahneman, D 76 Two Dogmas of Empiricism (Quine) 91 ultimatum bargaining 117–19 ultimatum games 95–6, 97–9, 119; inequity aversion theory 110 uncertainty: decision-making under 3–4 underdetermination 92–4, 140 unification 145–6 utility functions 107, 108, 109–10, 111, 136 utility maximisation 27 utility of the specific bundle variables 72, 73 Vischer et al 42 Vromen, J 49, 58–9 wages 51 weakness of will 36 Weisberg, M 18 Wimsatt, W 122–3 Winter, S 52, 53 .. .Philosophical Problems of Behavioural Economics The goal of behavioural economics is to improve the explanatory and predictive power of economics This can be achieved... Lehtinen, Jaako Kuorikoski and Petri Ylikoski Philosophical Problems of Behavioural Economics Stefan Heidl Philosophical Problems of Behavioural Economics Stefan Heidl First published 2016 by... relation of economics and psychology This debate has grown in intensity in recent years because of the rise to prominence of the economic subdiscipline of behavioural economics Adherents of behavioural