Behavioural economics

Insights from Adam Smith

Adam Smith, author of The Wealth of Nations, is often hailed as the father of modern economics. But in his less celebrated book The Theory of Moral Sentiments, he also foresaw the emerging discipline of behavioural economics. In fact, this book, written in 1759, helps explain everything from loss aversion to modern celebrity worship, and presaged a field that is only now emerging.

by The Journal of Economic Perspectives, Vol 19 No 3, summer 2005
Last Updated: 23 Jul 2013

Smith states that human behaviour is influenced by 'passions' - drivers such as fear, anger, hunger and sex. These are moderated by a 'voice of reason', an 'impartial spectator' that allows us to see that short-term gain can mean long-term pain. This insight is useful when making certain economic decisions such as those involving savings.

Smith would probably be thrilled by today's formal study of behavioural economics. The field draws on two areas he was passionate about: economic behaviour and psychological drivers. However, he rarely made deep links between the two. And it's not just the great man who didn't connect: although business leaders have long known that the two were associated, it is only in the past few years that they have had the tools to study such phenomena rigorously.

Economics has succeeded as a science because it has been able to simplify human behaviour into models and make predictions on the basis of these, but to do so it has had to sacrifice realism. But recently it has been able to 'reincorporate' these factors that Smith and others felt so important. Two of the most interesting (and least explored of these motivators) are social status and Smith's 'aerial coin of praise', which he saw as crucial drivers for economic activity.

Smith was also a great believer in virtues such as fairness and trust, which he thought vital for the function of a market economy. One might think these would diminish as markets develop, but if anything the reverse is true. In fact, Smith's advice to business leaders would be to think carefully about the costs of breaking trust and risking reputation. The costs of sacrificing ethical standards are much higher than the individual might imagine.

Source: Adam Smith, behavioural economist
Nava Ashraf, Colin Camerer and George Loewenstein
The Journal of Economic Perspectives, Vol 19 No 3, summer 2005

Review by Rhymer Rigby 

The Journal of Economic Perspectives, Vol 19 No 3, summer 2005 recommends

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