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I have edited this question considerably to narrow the focus.

A recent New York Times article was published on the Nobel Prize for Economics. The article discusses that Nobel laureate Richard Thaler was responsible for a push to account for human behavior in economic models:

...He showed that people depart from rationality in consistent ways, so their behavior can still be anticipated and modeled.

What is the historical context of resisting including these data in older models and what has influenced the paradigm shift?


More broadly, I am most interested in the question of why there was resistance historically in economic models when there is empirical evidence (cognitive neuroscience, psychology) going back for decades indicating that humans, in certain contexts, make decisions that may deviate from various definitions of "rational" choice. If this is not out of scope for this site (as pointed out in the comments) I would also like this to be a part of the answer to my question.

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  • $\begingroup$ If you want to know what economists mean by rationality I suggest looking at this post. economics.stackexchange.com/questions/17735/… $\endgroup$ – EconJohn Oct 11 '17 at 15:57
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    $\begingroup$ Keynes was one of the few who did not agree with the homo economicus view of human behaviour. Unfortunately, it was Hicks' mathematical version of Keynes worldview which became known as Keynesianism, version which neglected most of Keynes' insights about irrationality. Will provide an answer once I have time. $\endgroup$ – luchonacho Oct 11 '17 at 18:42
  • $\begingroup$ In the title, you ask "Was there ..." and I think the answer is simply "Yes ... here's the history of this assumption in economics ... here are the prominent economists who advocated it ..." But in the text, you ask "Why" and this is a much broader question that's not very suitable for this site. $\endgroup$ – Kenny LJ Oct 12 '17 at 23:58
  • $\begingroup$ @Kenny LJ Okay, fair enough. Let me think of a good way to make an edit that will narrow the focus of my question. $\endgroup$ – syntonicC Oct 13 '17 at 0:26
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I would recommend reading Thaler's Misbehaving, which chronicles the development of behavioral economics as a field and its struggle to gain recognition by mainstream economists. Several of its chapters (particularly, 6, 17-20) would directly answer your question regarding the historical context and partly the "why".

I share my own personal view below.

I believe the "as if" argument as advanced by Milton Friedman in his Essays in Positive Economics plays an important role in countering the move towards a relaxation of the rationality assumption. In a nutshell, the argument says that a theory should be judged by the accuracy of its predictions, not by the realism of its assumptions. Therefore, while the assumption of a rational decision-maker is not entirely realistic, the theory is doing a good job as long as it generates sufficiently accurate predictions (in the sense that they match what actually happens in the real world) based on such an assumption. Friedman describes a simple of model of billiard players that I think nicely illustrates his idea:

Consider the problem of predicting the shots made by an expert billiard player. It seems not at all unreasonable that excellent predictions would be yielded by the hypothesis that the billiard player made his shots as if he knew the complicated mathematical formulas that would give the optimum directions of travel, could estimate accurately by eye the angles, etc., describing the location of the balls, could make lightning calculations from the formulas, and could then make the balls travel in the direction indicated by the formulas. Our confidence in this hypothesis is not based on the belief that billiard players, even expert ones, can or do go through the process described; it derives rather from the belief that, unless in some way or other they were capable of reaching essentially the same result, they would not in fact be expert billiard players.

Thaler, and Kahneman and Tversky before him, mounted copious evidence that people consistently deviate from the behavioral benchmark set by the homo economicus. But to people like Friedman, this is not a sufficient cause for a change of paradigm, unless one brings conclusive evidence to show that the predictions made by rational choice models are wrong. It didn't help that experimental economists like Vernon Smith were successfully showing that (in the market context) people's collective behavior leads to outcomes consistent with rational choice theory. (In this regard, it does seem a bit ironic that Smith would share a Nobel with Kahneman).

Another reason against the paradigm shift could be in the interest of parsimony. Including more realistic behavioral foundations in economic models inevitably makes the models more complex. But if the simpler, albeit less realistically-founded, rational choice model can get things right just as well, there is a philosophical reason for favoring the latter. In a way, this is similar to the if-it-ain't-broke-don't-fix-it mentality.

Eventually, however, rational choice theory were found to fail to predict a lot of phenomena. For example, Nash equilibia are notoriously inaccurate in predicting how people actually behave in many games (e.g. Prisoners' Dilemma, ultimatum game, public goods game, and so on). And adding behavioral assumptions/relaxing the rationality assumption seemed like a natural way to "fix" existing models to increase their predictive power. Hence we have the rising popularity of behavioral economics these days. Still, these "behavioral patches" are often met with skepticism from of many traditional "rationalists". See this post for example.

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