Thursday, October 18, 2007

Do Psychologists understand the Economy better than Economists?

Peter Ayton is giving a talk next week entitled "Why Psychologists know more about Economic Behaviour than Economists".

Here's my thoughts.

I feel the problem is that most psychologists have a caricatured view of economists, that may be true for large parts of the profession, or those trained a long time ago, but amongst "good" economists which is probably most economists at top schools, economists have a much more nuanced view.

Psychologists may know more about specific behaviors in certain contexts, but are probably less able to make predictions about what happens in the economy at large. Good economists know their models are flawed, but accept our models as useful tools, that match patterns and can make predictions in most of the economy. Sure, they do not capture all the nuances that psychologists care about, but they accept that as a trade off for more tractability.

Like if I was asked, what is the impact of a refinery outage on the price of oil, though psychologists will know that fear and herding may drive some effects, economists know that supply and demand is likely the best predictor, and in fact, can show the statistics that prove it.

It is also an application of the overconfidence effect. David Dunning was on NPR a couple days ago talking about how the robust finding in psychology that everyone thinks they are above average. Applied to this case, both economists and psychologists think they are better at understanding the economy.

Economists have recently reconciled these findings (a couple recent papers in the American Economic Review) by arguing that everyone can believe they are better than average, because everyone defines "better" in a different way. Economists and psychologists just care about different questions when thinking about the economy, and each group probably does know more about the questions that they care about.

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