Richard Thaler and the Rise of Behavioral Economics

• Date: 01 July 2018
• DOI: http://doi.org/10.1111/sjoe.12313
• Author: Nicholas Barberis
• Published date: 01 July 2018

Scand. J. of Economics 120(3), 661–684, 2018

DOI: 10.1111/sjoe.12313

Richard Thaler and the Rise of Behavioral

Economics*

Nicholas Barberis

YaleSchool of Management, New Haven CT 06520-8200, USA

nick.barberis@yale.edu

Abstract

Richard Thaler was awarded the 2017 Sveriges Riksbank Prize in Economic Sciences in

Memory of Alfred Nobel for his contributions to behavioral economics. In this article, I review

and discuss these contributions.

Keywords: Endowment effect; mental accounting; nudge; prospect theory

JEL classification:B2; D9; G1

I. Introduction

From the 18th century to the first half of the 20th century, the leading

economists of the day – figures such as Adam Smith, John Maynard Keynes,

and Irving Fisher – were known to bring aspects of human psychology

into their analysis of the economy. By the middle of the 20th century,

however, this practice was less common, and with the advent of the rational

expectations revolution in the 1960s, economists began to focus almost

exclusively on models with the same, tightly specified assumptions about

individual psychology: that people have rational beliefs, and that they make

decisions according to expected utility.

In the early 1980s, a small group of economists began to feel that

the rational expectations revolution had gone too far. They argued that, in

order to understand many important economic phenomena, it was critical

to develop new models that made assumptions about human behavior

that were psychologically more realistic and, in particular, allowed for

less than fully rational thinking. This message was roundly dismissed at

first, sometimes in scornful terms, but it gradually gained traction. Today,

behavioral economics – the effort to improve our understanding of the

economy through psychologically realistic models – is firmly established:

*The author is grateful to Hunt Allcott, Ingvild Alm˚as, James Choi, Stefano DellaVigna, Keith

Ericson, Owen Lamont, Ulrike Malmendier, Matthew Rabin, and Jesse Shapiro for helpful

discussions about the content of this article.

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The editors of The Scandinavian Journal of Economics 2018.

662 Richard Thaler and the rise of behavioral economics

hundreds of papers in this tradition, many of them highly cited, have

appeared in the top economics and finance journals; dozens of specialists in

the area have been hired and tenured at leading universities; and conferences

on the topic attract large and growing crowds. Moreover, this approach to

economics has generated significant interest beyond academia, among non-

academic economists, policy makers, and the public at large.

The growth of behavioral economics over the decades is the result of

a collective effort by many researchers. However, if there is one person

who was central to the rise of behavioral economics, particularly in its

early years, it would be Richard Thaler, the 2017 Nobel Laureate in

economics. To appreciate how central he was, consider the four factors

that have driven the growth of the field. First, researchers documented

numerous “anomalies” (i.e., empirical facts that are hard to reconcile

with the traditional, rational model of economic behavior). Second, they

developed a new generation of models based on more psychologically

realistic assumptions. Third, they found ways of helping people to make

better economic decisions. Fourth, the behavioral economics movement

attracted talented young researchers who accelerated the development of

the field.

Thaler played an important role in all four of these factors. First,

he documented a number of anomalies, and emphasized these and other

anomalies relentlessly, most famously in a series of columns in the Journal

of Economic Perspectives. Second, he began the effort to develop new,

more psychologically realistic frameworks, and several of the intuitions

he described decades ago remain at the core of the latest models. Third,

he was at the forefront of finding ways to improve people’s economic

decisions, most notably through his efforts to raise saving rates in US

retirement plans. Fourth, he was the primary mentor to the generation of

behavioral economists that followed him. In the course of making these

broad contributions, Thaler came up with a number of specific concepts and

ideas that have endured, including the endowment effect, mental accounting,

and the Save More Tomorrow plan for increasing saving. However, perhaps

his single most influential insight – one that relates to the second of the

four factors – was his recognition, after encountering the work of Daniel

Kahneman and Amos Tversky, that their research on the psychology of

judgment and decision-making was the key to developing a new generation

of more psychologically realistic economic models.

In this article, I review Thaler’s contributions in more detail. The article

is structured around the four factors I listed above. In Section II, I discuss

the anomalies that Thaler studied. In Section III, I describe the many ways

in which he influenced the development of behavioral economics models.

In Section IV, I review his research on ways to improve economic decision-

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The editors of The Scandinavian Journal of Economics 2018.