Economists are often chided for their “unrealistic” behavioral assumptions, specifically rational self-interest.  An obvious direction for research was to relax some of these assumptions, often with surprising results.  Indeed, the Nobel Prize in economics has gone to scholars such as Herb Simon and Daniel Kahneman for work that took a hard look at the rational man assumption.  But I would probably point to the blockbuster, almost freakish success of Freakonomics and Super-Freakonmomics, texts that sometimes venture into this realm, that put behavioral economics in the public eye.

George Lowenstein
George Lowenstein

Despite the success of behavioral economics and finance, we have to be careful how far we want to push it. “[I]t’s becoming clear that behavioral economics is being asked to solve problems it wasn’t meant to address,” says Carnegie Mellon’s George Lowenstein, one of the giants in the field. Writing a cautionary op-ed in today’s  New York Times, Lowenstein and his co-author give a number of examples where reliance on behavioral results can miss the forest through the trees.

A “gallons-per-mile” bill recently passed by the New York State Senate is intended to help drivers think more clearly about the fuel consumption of the vehicles they purchase; research has shown that gallons-per-mile is a more effective means of getting drivers to appreciate the realities of fuel consumption than the traditional miles-per-gallon.

But more and better information fails to get at the core of the problem: people drive large, energy-inefficient cars because gas is still relatively cheap. An increase in the gas tax that made the price of gas reflect its true costs would be a far more effective — though much more politically painful — way to reduce fuel consumption.

I think the LU economists are with Lowenstein on this one.  We believe that you need to be grounded with a clear understanding of the fundamentals in order to understand the strengths and weaknesses of the discipline.