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Economic Psychology - Introduction
Economics
social science that
seeks to analyze
and describe the
production,
distribution, and
consumption of
wealth.
Economic
psychology
Compiled by
Mart Murdvee
Economics and economic problem
Economics,
• Economics is the science of how a particular
society solves its economic problems.
• An economic problem exists whenever scarce
means are used to satisfy alternative ends.
– If the means are not scarce, there is no problem at all; there is Nirvana.
– If the means are scarce but there is only a single end, the problem of how to
use the means is a technological problem. No value judgments enter into its
solution; only knowledge of physical and technical relationships. For example,
suppose given amounts of iron, labor, etc. are available and are to be used to
build an engine of maximum horsepower. This is a purely technical problem
that requires knowledge solely of engineering and of physical science.
– Alternatively, let the objective be to build the "best" engine, where the concept
of „best" involves not only horsepower, but also weight, size, etc. There is no
longer a single end. No amount of purely physical and technical knowledge
can yield a solution, since such knowledge cannot tell you how much power it
is "worth" sacrificing to save a certain amount of weight. This is an economic
problem, involving value judgments.
Milton Friedman
1912 - 2006
(Friedman, 2008)
Subdisciplines of economics:
• behavioural economics,
• psychological economics,
• cognitive economics
• neuroeconomics
Economists are increasingly abandoning the
assumption that people are fully rational in their
choices, and are becoming increasingly interested
in constructing models which incorporate realistic
assumptions about human thought and behaviour.
by our definition, is not concerned
with all economic problems. It is a
social science, and is therefore
concerned primarily with those
economic problems whose solution
involves the cooperation and
interaction of different individuals. It is
concerned with problems involving a
single individual only insofar as the
individual's behavior has implications
for or effects upon other individuals.
Furthermore, it is concerned not with
the economic problem in the abstract,
but with how a particular society
solves its economic problems.
(Friedman, 2008)
Three levels of scientific question and
associated scientific disciplines
Domains of study
(Level of question)
Level of explanation
Market behaviour
Small group decisionmaking
Cognitive processes in
judgement and
decision-making
Human collectives
Sociology
Social psychology
Cognitive psychology
Human individuals
Individual values and
preferences
Brain and body function
Kinds of science
Economics
Social cognition
Brain and body parts
and systems
Neuroscience
(Lewis. 2008)
© Mart Murdvee 2013-15
1
Economic Psychology - Introduction
Nonlinear systems
A system will generate nonlinear behavior only if:
i.
ii.
iii.
iv.
It is open, able to exchange matter and/or energy with its environment.
Its evolution can be described by non-linear differential equations.
The equations describing its evolution allow for positive feedback.
It is sufficiently far from internal equilibrium.
Under these conditions microscopic fluctuations within the system may not
be suppressed, but may be amplified to the point that they bring a new
macroscopic order to the system, an order that is typically cyclic.
Homo Economicus
the rational choice model:
IF
profitA= revenueA- costsA
profitB= revenueB- costsB
.....
profitn= revenuen- costsn
AND
profitA > profitB > … > profitn
THEN
A
Economies satisfy these conditions:
i.
ii.
iii.
iv.
They are open and exchange matter and energy with their environment
(e.g. trade).
Their evolution can be described by nonlinear differential equations.
They commonly exhibit positive feedback. Higher inflation → higher
inflation expectations → a propensity to spend faster, before prices rise
further → a higher velocity of money → still higher inflation…
They are often removed from internal equilibrium. With respect to the
distribution of wealth, the more wealth concentrates in fewer hands, the
further removed is the economy from internal equilibrium.
Invisible Hand
Tragedy Of The Commons
Every individual necessarily labours to render the
annual revenue of the society as great as he can.
He generally neither intends to promote the public
interest, nor knows how much he is promoting it ...
He intends only his own gain, and he is in this, as
in many other cases, led by an invisible hand to
promote an end which was no part of his intention.
Nor is it always the worse for society that it was
no part of his intention. By pursuing his own
interest he frequently promotes that of the society
more effectually than when he really intends to
promote it. I have never known much good done
by those who affected to trade for the public good.
Adam Smith
1723?-1790
is the concept in many
economic theories of humans
as rational and narrowly selfinterested actors who have the
ability to make judgments
toward their subjectively defined
ends.
MINIMAX
"An Inquiry into the Nature and Causes of the
Wealth of Nations„ 1776
Altruism is bound by what one can afford
The expanding circle of human
morality is actually a floating
pyramid. Altruism is spread
thinner the farther away we get
from our immediate family or
clan. Its reach depends on
resources and affordability; the
pyramid's buoyancy determines
how much of it will emerge from
the water. The moral inclusion of
outer circles is thus constrained
by obligations to the inner ones.
The ideal of universal
brotherhood is unrealistic in that
it fails to distinguish between
these innermost and outermost
circles of obligation.
•
Garrett James Hardin
1915 – 2003
•
An economic problem in which every individual tries to
reap the greatest benefit from a given resource. As the
demand for the resource overwhelms the supply, every
individual who consumes an additional unit directly harms
others who can no longer enjoy the benefits. Generally, the
resource of interest is easily available to all individuals.
The tragedy of the commons occurs when individuals
neglect the well-being of society (or the group) in the
pursuit of personal gain. For example, if neighboring
farmers increase the number of their own sheep living on a
common block of land, eventually the land will become
depleted and not be able to support the sheep, which is
detrimental to all.
•
Carrying Capacity as an Ethical Concept - „Lifeboat ethics“
–
Situational ethics: The morality of an act is determined by the
state of the system at the time the act is performed. Ecology, a
systembased view of the world, demands situational ethics.
Labour Theory of Value
• Value of a commodity is the socially
necessary labour time invested in it.
• Capitalists do not pay workers the full
value of the commodities they produce;
rather, they compensate the worker for
the necessary labor only (the worker's
wage, which cover only the necessary
means of subsistence in order to
maintain him working in the present
and his family in the future as a group).
This necessary labor is, Marx
supposes, only a fraction of a full
working day - the rest, the surpluslabor, would be pocketed by the
capitalist.
Karl Marx
1818 – 1883
Frans de Waal (1996) Good Natured. The Origins of
Right and Wrong in Humans and Other Animals. p. 213
© Mart Murdvee 2013-15
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Economic Psychology - Introduction
Manifesto of the Communist Party
The immediate aim of the Communists
is the same as that of all other
proletarian parties: formation of the
proletariat into a class, overthrow of
the bourgeois supremacy, conquest of
political power by the proletariat.
…the theory of the Communists may
be summed up in the single sentence:
Abolition of private property.
We Communists have been
reproached with the desire of
abolishing the right of personally
acquiring property as the fruit of a
man’s own labour, which property is
alleged to be the groundwork of all
personal freedom, activity and
independence.
HUMAN action is purposeful
behavior. Or we may say: Action
is will put into operation and
transformed into an agency, is
aiming at ends and goals, is the
ego’s meaningful response to
stimuli and to the conditions of its
environment, is a person’s
conscious adjustment to the state
of the universe that determines
his life.
Ludwig von Mises
1881 – 1973
1949
Karl Marx and Frederick Engels,1848
Value: The Law of Marginal Utility
Keynesian economycs
The satisfaction derived from food and that
derived from the enjoyment of a work of art
are, in acting man’s judgment, a more urgent
or a less urgent need; valuation and action
place them in one scale of what is more
intensively desired and what is less. For acting
man there exists primarily nothing but various
degrees of relevance and urgency with regard
to his own well-being.
The value that an individual attaches both to
money and to various goods and services is
the outcome of a moment’s choice. Every later
instant may generate something new and bring
about other considerations and valuations.
Keynesian multiplier
• Exogenous increases in spending, such as an increase in
government outlays, increases total spending by a multiple
of that increase. A government could stimulate a great
deal of new production with a modest outlay if:
– The people who receive this money then spend most on
consumption goods and save the rest.
– This extra spending allows businesses to hire more
people and pay them, which in turn allows a further
increase in consumer spending.
• This process continues. At each step, the increase in
spending is smaller than in the previous step, so that the
multiplier process tapers off and allows the attainment of
an equilibrium.
© Mart Murdvee 2013-15
Private sector decisions
sometimes lead to inefficient
macroeconomic outcomes which
require active policy responses
by the public sector, in particular,
monetary policy actions by the
central bank and fiscal policy
actions by the government, in
order to stabilize output over the
business cycle.
Mixed economy – predominantly
private sector, but with a role for
government intervention during
recessions.
John Maynard Keynes
1883 – 1946
Welfare state
a concept of government in which
the state plays a key role in the
protection and promotion of the
economic and social well-being of
its citizens. It is based on the
principles of equality of
opportunity, equitable distribution
of wealth, and public
responsibility for those unable to
avail themselves of the minimal
provisions for a good life. The
general term may cover a variety
of forms of economic and social
organization.
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Economic Psychology - Introduction
Socialism
Limitation of the rights of owners as well as
formal transference is a means of socialization.
If the State takes the power of disposal from the
owner piecemeal, by extending its influence
over production; if its power to determine what
direction production shall take and what kind of
production there shall be, is increased, then the
owner is left at last with nothing except the
empty name of ownership, and property has
passed into the hands of the State.
Protestant Work Ethic and Spirit of
Capitalism
•
•
•
… business leaders and owners of capital, as
well as the higher grades of skilled labour, and
even more the higher technically and
commercially trained personnel of modern
enterprises, are overwhelmingly Protestant.
… the Protestants both as ruling classes and
as ruled, both as majority and as minority, have
shown a special tendency to develop economic
rationalism which cannot be observed to the
same extent among Catholics either in the one
situation or in the other.
Thus the principal explanation of this difference
must be sought in the permanent intrinsic
character of their religious beliefs, and not only
in their temporary external historico-political
situations.
Maximilian Karl Emil Weber
1864 - 1920
von Mises (1951) Socialism
Massive concentration of economic
resources in the hands of fewer people
The percentage increase in share of income of the
richest one percent, 1980–2012
• Almost half of the world’s wealth is now owned by just one percent
of the population.
• The wealth of the one percent richest people in the world amounts
to $110 trillion. That’s 65 times the total wealth of the bottom half
of the world’s population.
• The bottom half of the world’s population owns the same as the
richest 85 people in the world.
• Seven out of ten people live in countries where economic
inequality has increased in the last 30 years.
• The richest one percent increased their share of income in 24 out
of 26 countries for which we have data between 1980 and 2012.
• In the US, the wealthiest one percent captured 95 percent of postfinancial crisis growth since 2009, while the bottom 90 percent
became poorer.
Oxsfam (2014) WORKING FOR THE FEW - Political capture and economic
inequality
The concentration of global wealth
Qualities of successful groups:
1. A superiority complex: they believe themselves to be superior
to other groups.
2. Insecurity: deeply insecure about their place in society - can be
a motivating drive to achieving success.
3. Impulse Control: extraordinary sense of self-discipline on their
children. Impulse control - the ability to resist temptation,
especially the temptation to give up in the face of hardship or quit
instead of persevering at a difficult task.
Successful (by income, occupational status, test scores, etc) groups
in USA: Chinese, Jewish, Indian, Iranian, Lebanese-Americans,
Nigerians, Cuban exiles, Mormons.
Amy Chua and Jed Rubenfeld (2014) The Triple Package: How Three Unlikely Traits Explain the
Rise and Fall of Cultural Groups in America. Oenguin Press.
© Mart Murdvee 2013-15
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Economic Psychology - Introduction
Problem
Market + Democracy = ?
• Market-dominant minorities: ethnic minorities who, for widely
varying reasons, tend under market conditions to dominate
economically, often to a startling extent, the “indigenous” majorities
around them.
•
•
(In 1998, Chinese Indonesians, only 3 percent of the population, controlled roughly 70 percent of Indonesia’s
private economy, including all of the country’s largest conglomerates)
• Market-dominant minorities are the Achilles’ heel of free market
democracy. In societies with a market-dominant ethnic minority,
markets and democracy favor not just different people, or different
classes, but different ethnic groups. Markets concentrate wealth,
often spectacular wealth, in the hands of the market-dominant
minority, while democracy increases the political power of the
impoverished majority. In these circumstances the pursuit of free
market democracy becomes an engine of potentially catastrophic
ethnos nationalism, pitting a frustrated “indigenous” majority, easily
aroused by opportunistic vote-seeking politicians, against a
resented, wealthy ethnic minority.
(Amy Chua, 2004)
•
•
•
In the numerous societies around the world that have a market-dominant minority,
markets and democracy are not mutually reinforcing.
Because markets and democracy benefit different ethnic groups in such
societies, the pursuit of free market democracy produces highly unstable and
combustible conditions.
Markets concentrate enormous wealth in the hands of an “outsider” minority,
fomenting ethnic envy and hatred among often chronically poor minorities.
Introducing democracy in these circumstances does not transform voters into
open-minded co-citizens in a national community. Rather, the competition for
votes fosters the emergence of demagogues who scapegoat the resented
minority and foment active ethnonationalist movements demanding that the
country’s wealth and identity be reclaimed by the “true owners of the nation.”
When free market democracy is pursued in the presence of a market-dominant
minority; the almost invariable result is backlash. This backlash typically takes
one of three forms.
– The fist is a backlash against markets, targeting the market-dominant minority’s wealth.
– The second is a backlash against democracy by forces favorable to the market-dominant
minority.
– The third is violence, sometimes genocidal, directed against the market-dominant minority
itself.
Chua, Amy (2003) World on fire - how exporting free market democracy breeds ethnic hatred and global instability
Market + Democracy = ?
Critics of globalization are right to demand that
more attention be paid to the enormous wealth
disparities created by global markets. But just as it
is dangerous to view markets as the panacea for
the world’s poverty and strife, so to it is dangerous
to see democracy as a, panacea. Markets and
democracy may well offer the best long-run
economic and political hope for developing and
post-Communist societies. In the short run,
however, they are part of the problem.
Chua, Amy (2003) World on fire - how exporting free market democracy breeds ethnic hatred and global instability
Зазубрин (1923) Щепка
Расстрельщики Че-Ка
•
Трое стреляли как автоматы. И глаза у них были
пустые, с мертвым стеклянистым блеском. Все,
что они делали в подвале, делали почти
непроизвольно. Ждали, пока приговоренные
разденутся, встанут, механически поднимали
револьверы, стреляли, отбегали назад, заменяли
расстрелянные обоймы заряженными. Ждали,
когда уберут трупы и приведут новых. Только
когда осужденные кричали, сопротивлялись, у
троих кровь пенилась жгучей злобой. Тогда они
матерились, лезли с кулаками, с рукоятками
револьверов. И тогда, поднимая револьверы к
затылкам голых, чувствовали в руках, в груди
холодную дрожь. Это от страха за промах, за
ранение. Нужно было убить наповал. И если
недобитый визжал, харкал, плевался кровью, то
становилось душно в подвале, хотелось уйти и
напиться до потери сознания. Но не было сил.
Кто-то огромный, властный заставлял
торопливо поднимать руку и приканчивать
раненого.
© Mart Murdvee 2013-15
Lack of Fairness?
During the evolution of cooperation it may have become critical for individuals to compare their own efforts
and pay-offs with those of others. Negative reactions may occur when expectations are violated. One theory
proposes that aversion to inequity can explain human cooperation within the bounds of the rational choice
model, and may in fact be more inclusive than previous explanations. Although there exists substantial
cultural variation in its particulars, this ‘sense of fairness’ is probably a human universal that has been shown
to prevail in a wide variety of circumstances. However, we are not the only cooperative animals, hence
inequity aversion may not be uniquely human. Many highly cooperative nonhuman species seem guided by a
set of expectations about the outcome of cooperation and the division of resources. Here we demonstrate
that a nonhuman primate, the brown capuchin monkey (Cebus apella), responds negatively to unequal
reward distribution in exchanges with a human experimenter. Monkeys refused to participate if they witnessed
a conspecific obtain a more attractive reward for equal effort, an effect amplified if the partner received such a
reward without any effort at all. These reactions support an early evolutionary origin of inequity aversion.
Brosnan & de Waal, 2003
Creative destruction
describes the "process of industrial mutation
that incessantly revolutionizes the economic
structure from within, incessantly destroying
the old one, incessantly creating a new one“.
•
•
•
Joseph Schumpeter
1883 – 1950
•
•
Innovative entry by entrepreneurs was the disruptive
force that sustained economic growth, even as it
destroyed the value of established companies and
laborers that enjoyed some degree of monopoly power
derived from previous technological, organizational,
regulatory, and economic paradigms.
Innovation comes from the individual entrepreneur, not
labour, government, or social relations.
Social relations are anti-innovative, so innovation must
destroy/disrupt companies, industries, communities.
Governance – expressed as bureaucracy, democracy,
unions, faculty senates – is also anti-innovative.
Innovation always means replacing human labour with
technology.
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Economic Psychology - Introduction
Prosperity around the World 2008
•
•
•
Modernization theory
Geography hypothesis - the
divide between rich and poor
countries is created by
geographical differences
Culture hypothesis (Max
Weber) - the Protestant
Reformation and the Protestant
ethic played a key role in
facilitating the rise of modern
industrial society in Western
Europe. The culture hypothesis
no longer relies solely on
religion, but stresses other types
of beliefs, values, and ethics as
well.
Ignorance hypothesis - world
inequality exists because we or
our rulers do not know how to
make poor countries rich.
Seymour Martin Lipset
1922 – 2006)
all societies, as they grow, are headed toward
a more modern, developed, and civilized
existence, and in particular toward democracy.
• democracy will emerge as a by-product of
the growth process
• regular elections and relatively
unencumbered political competition are
likely to bring forth the development of
inclusive political institutions
• educated workforce will naturally lead to
democracy and better institutions.
Once a country got enough McDonald’s
restaurants, democracy and institutions were
bound to follow.
Daron Acemoglu, James A. Robinson (2012). Why nations fail: the origins of
power, prosperity, and poverty. Crown Publishers, New York.
Inclusive economic institutions
Extractive economic institutions
• allow and encourage participation by the great mass
of people in economic activities that make best use of
their talents and skills and that enable individuals to
make the choices they wish.
• To be inclusive, economic institutions must feature:
are synergistically linked to extractive political institutions,
which concentrate power in the hands of a few, who will then
have incentives to maintain and develop extractive economic
institutions for their benefit and use the resources they obtain
to cement their hold on political power.
• Nations fail economically because of extractive institutions.
These institutions keep poor countries poor and prevent
them from embarking on a path to economic growth. This
is true today in Africa, in places such as Zimbabwe and
Sierra Leone; in South America, in countries such as
Colombia and Argentina; in Asia, in countries such as
North Korea and Uzbekistan; and in the Middle East, in
nations such as Egypt.
– secure private property,
– an unbiased system of law, and
– a provision of public services that provides a level playing
field in which people can exchange and contract;
– it also must permit the entry of new businesses and allow
people to choose their careers.
• Extractive economic institutions
Why some nations are prosperous
while others fail and are poor:
Strong synergy between economic
and political institutions
• the distinction between extractive and
inclusive economic and political institutions.
• why inclusive institutions emerged in some
parts of the world and not in others.
While the first level of our theory is about an
institutional interpretation of history, the second
level is about how history has shaped
institutional trajectories of nations.
• There is strong synergy between economic and political institutions.
Extractive political institutions concentrate power in the hands of a narrow
elite and place few constraints on the exercise of this power. Economic
institutions are then often structured by this elite to extract resources from
the rest of the society. Extractive economic institutions thus naturally
accompany extractive political institutions. In fact, they must inherently
depend on extractive political institutions for their survival. Inclusive
political institutions, vesting power broadly, would tend to uproot
economic institutions that expropriate the resources of the many, erect
entry barriers, and suppress the functioning of markets so that only a few
benefit.
• This synergistic relationship between extractive economic and political
institutions introduces a strong feedback loop: political institutions enable
the elites controlling political power to choose economic institutions with
few constraints or opposing forces. They also enable the elites to
structure future political institutions and their evolution. Extractive
economic institutions, in turn, enrich the same elites, and their economic
wealth and power help consolidate their political dominance.
© Mart Murdvee 2013-15
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Economic Psychology - Introduction
Iron law of oligarchy
Robert Michels, 1911
All organizations eventually come to be run by a "leadership class", who often function as paid
administrators, executives, spokespersons, political strategists, organizers, etc. for the
organization. Far from being "servants of the masses" this "leadership class" will inevitably grow
to dominate the organization's power structures rather than its membership. By controlling who
has access to information, those in power can centralize their power successfully, often with
little accountability, due to the apathy, indifference and non-participation most rank-and-file
members have in relation to their organization's decision-making processes.
Democratic attempts to hold leadership positions accountable are prone to fail, since with
power comes:
– the ability to reward loyalty,
– the ability to control information about the organization, and
– the ability to control what procedures the organization follows when making decisions.
All of these mechanisms can be used to strongly influence the outcome of any decisions made
'democratically' by members.
All forms of organization, regardless of how democratic they may be at the start, will eventually
and inevitably develop oligarchic tendencies, thus making true democracy practically and
theoretically impossible, especially in large groups and complex organizations. The relative
structural fluidity in a small-scale democracy succumbs to "social viscosity" in a large-scale
organization. Democracy and large-scale organization are incompatible.
Changes = institutional drift +
critical junctures
• Conflict over income and power, and indirectly
over institutions, is a constant in all societies. This
conflict often has a contingent outcome, even if the
playing field over which it transpires is not level.
The outcome of this conflict leads to institutional
drift.
• Major institutional change, the requisite for major
economic change, takes place as a result of the
interaction between existing institutions and critical
junctures. Critical junctures are major events that
disrupt the existing political and economic balance
in one or many societies
• Though institutional drift leads to small differences,
its interplay with critical junctures leads to
institutional divergence, and thus this divergence
then creates the now more major institutional
differences that the next critical juncture will affect.
References
• Lewis Ed. (2008) The Cambridge Handbook of Psychology and
Economic Behaviour. Cambridge University Press, Cambridge
• Milton Friedman (2008). Price Theory. Babylon Publishing.
• Ludwig von Mises (1949). Human Action: A Treatise on Economics. Yale.
• Adam Smith (1776/1977) An Inquiry Into the Nature and Causes of the
Wealth of Nations. ElecBook Classics
• Max Weber (1930/2005) The Protestant Ethic and the Spirit of
Capitalism. Routledge Classics
• Amy Chua (2004). World on Fire: How Exporting Free Market Democracy
Breeds Ethnic Hatred and Global Instability. Anchor Books.
• Oxsfam (2014) WORKING FOR THE FEW - Political capture and
economic inequality.
• Daron Acemoglu, James A. Robinson (2012). Why nations fail: the origins
of power, prosperity, and poverty. Crown Publishers, New York.
© Mart Murdvee 2013-15
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