Incorporating More Realistic Psychological Assumptions into Economics

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This project involves efforts to incorporate more realistic psychological assumptions into formal economics, both at a general level and in particular economic applications. The research emphasizes two general areas. First, many social scientists have criticized mainstream economics as too narrowly focused on how people pursue their material self- interest, ignoring social goals such as fairness. The project involves developing a general game-theoretic model of the fact that people try to help those who help them and hurt those who hurt them. The model's implications in several economic situations are considered, and it is shown how consumer concerns over fairness will lead a monopolist to lower its price. The second area of research is to understand the economic implications of "loss aversion" and the "endowment effect." These notions summarize strong psychological evidence of seemingly central features of human preferences: our utility from consumption is heavily influenced by our status quo, and we tend to weigh losses relative to this status quo more heavily than gains. Foundations are developed for incorporating such issues, and economic applications are pursued. The main application under development is consumer dynamic savings-versus-consumption decisions, investigating whether consumers tend to resist lowering their consumption in response to bad news about future income. This research brings more realism to economic models by incorporating well-established psychological findings. It takes a significant step toward building a useful and descriptive theory to enhance our understanding of human behavior.