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1 August 2013 CFA Institute Journal Review

The Debt to Pleasure (Digest Summary)

  1. Michal Szudejko

Existing economic models often fail to explain real-life behavior. The author offers several examples of behavioral patterns that are not explained by current models. Contemporary economists should pay closer attention to developments in such sciences as psychology, neuroscience, and anthropology if they want their models to achieve a closer relationship with real-life economic decisions.

What’s Inside?

The author discusses the latest paper by Daniel McFadden (NBER Working Paper No. 18687, February 2013) and the potential need to extend existing economic models. Multiple behavioral patterns are not explained by the current models. Therefore, modified versions of these models that encompass such behavioral patterns would be helpful in decision making.

How Is This Article Useful to Practitioners?

Several common behavioral patterns have no representation in existing economic models. For example, contrary to what most economic models assume, people often change their preferences over time and under different circumstances. Their decisions might be influenced by the way they remember different events, the way they perceive achieving profits or incurring losses, or the interactions with others that they expect certain decisions to lead to.

Contemporary economists need to source their knowledge from, for instance, psychology, neuroscience, or anthropology if they want their models to mimic real life in a more precise manner. The article may be of interest to economists, practitioners, and academics. Although the author only attempts to justify the revision of existing models with no clear recipe for doing so, the article could inspire further work.

Abstractor’s Viewpoint

This article is journalistic rather than scientific. Nevertheless, it may serve as a motivation to reconsider a familiar approach. The author raises several important questions. The key one is whether trying to understand economic reality (and, in fact, human behavior) by incorporating several simplifying assumptions is still justified considering the current level of knowledge in various fields of social science.

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