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Behavioural Economics: The New Era - Essay Example

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The Standard economic models are often questioned for the fairness of their assumptions. It seems like the assumptions for explaining the theories to be addressed are cyclical or in other words, they are assumed in such a manner that they are bound to produce the hypothesized outcomes…
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Behavioural Economics: The New Era
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In this essay, we have mainly tried to analyze the weakness of the assumptions of standard economic model and figure out the alternative approaches in order to deal with the economic problems. It has been observed that standard economics do face a lot of limitations in its assumptions to predict reality.

To have a better understanding of the standard model of economics, recently a relatively newer concept of economics has been seen to emerge. Behavioural economics is the one which infuses the elements of psychology and neuroscience in order to have a better understanding of economics. In fact owing to the aftermath of the recent global economic crisis, it is now believed that irrationality truly drives the decision making abilities. This essay will explore two of the very basic ideas of standard economic behaviour, rational expectations and consistent preferences. This paper will also explain the possible shortcomings of these two assumptions, thereby considering the alternative approaches that can mitigate these shortcomings. Standard economic models and weaknesses In the model of consumer behaviour, which is one of the most fundamental economic models, it is assumed that all the consumers are rational and are guided by unbound willpower and complete knowledge for making decisions. This traditional approach of rational expectations has two sub-types, strong rational expectations and weak rational expectations....
It has now been fully understood that it is irrationality, which often guides through the decision making process. Given that human beings are often driven by cognitive biases, it plays an important role in their true decision making process (Diamond and Vartiainen, 2007). Mainstream economics is characterized by a number of underlying assumptions like rational expectations, representative agents and consistent preferences. This school of thought draws from the views of neo-classical economics, neo-classical synthesis and also the Keynesian Economics. The approach based on this method is mostly based on the probabilistic theories and theories of mathematical expectations. The entire discipline is based on the deductive analysis of mathematical models. The broad purpose of economics as a whole is to understand the interaction among people among various sectors like business and commerce, in organization of production, in government operations and also the making of public decisions. It is the interaction of people in the daily lives that economics bases its assumption on. The approach of mathematical models for predicting the outcome of decisions made by economic agents is not necessarily wrong. However, this approach is not a strictly consistent one. One of the basic assumptions in standard models of economics is that people have a strict methodical approach of looking into the future. Models based on this concept assume that exponential discount function is consistent during their entire lifetime. However, there are both theoretical literature and empirical evidences to prove otherwise. Reality has shown that people do not always plan their lives in a mechanical way in line with the ...Download file to see next pagesRead More
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