of the process) for helpful comments. 1 Behavioral economics increases the explanatory power of economics by providing it with more realistic psychological foundations. This book consists of representative recent articles in behavioral economics. 1 This chapter is intended to provide an introduction to the approach and methods of behavioral economics, and to some of its major findings, applications, and promising new directions. It also seeks to fill some unavoidable gaps in the chapters ’ coverage of topics. What Behavioral Economics Tries To Do At the core of behavioral economics is the conviction that increasing the realism of the psychological underpinnings of economic analysis will improve economics on its own terms--generating theoretical insights, making better predictions of field phenomena, and suggesting better policy. This conviction does not imply a wholesale rejection of the neoclassical approach to economics based on utility maximization, equilibrium, and efficiency. The neoclassical approach is useful because it provides economists with a theoretical framework that can be applied to almost any form of economic (and even non-economic) behavior, and it makes refutable predictions. Many of these predictions are tested in the chapters of this book, and rejections of those predictions suggest new theories. Most of the papers modify one or two assumptions in standard theory in the direction of greater psychological realism. Often these departures are not radical at all because they relax simplifying assumptions that are not central to the economic approach. For example, there is nothing in core neoclassical theory that specifies that people should not care about fairness, that they should weight risky outcomes in a linear fashion, or that they must discount the future exponentially at a constant rate. 2 Other assumptions simply acknowledge human limits on 1 Since it is a book of advances, many of the seminal articles which influenced those collected here are not included, but are noted below and are widely reprinted elsewhere.

All around the world, in both the public and private sectors, retirement plans are shifting away from “defined benefit” plans toward “defined contribution” plans. Poterba, Venti, and Wise (2006), for example, followed the cohort of Americans who were 45 years old in 1984 and report a decrease in defined benefit plan coverage from about 40 percent to 20 percent and a corresponding increase in defined contribution plan coverage from about 5 percent to more than 30 percent. Defined contribution plans have many attractive features for participants, such as portability and flexibility, but these attractions come with an increased responsibility to choose wisely. The plans also provide economists with an attractive domain in which to study saving behavior. The standard economic theories of saving (like the life-cycle or permanent income models) contain three embedded rationality assumptions, one explicit and two implicit. The explicit assumption is that savers accumulate and then decumulate assets to maximize some lifetime utility function (possibly including bequests). The first implicit assumption is that households have the cognitive ability to solve

We develop a rational dynamic model in which people are loss averse over changes in beliefs about present and future consumption. Because changes in wealth are news about future consumption, preferences over money are reference-dependent. If news resonates more when about imminent consumption than when about future consumption, a decision maker might (to generate pleasant surprises) overconsume early relative to the optimal committed plan, increase immediate consumption following surprise wealth increases, and delay decreasing consumption following surprise losses. Since higher wealth mitigates the effect of bad news, people exhibit an unambiguous first-order

Foundation for their support. The usual disclaimer applies. 2

The authors would like to thank the three anonymous reviewers for their helpful comments. INCOMMENSURATE RESOURCES: NOT JUST MORE OF THE SAME The pricing literature is replete with research focusing on how consumers respond to sales promotions when both the reference level and the change are expressed in dollar terms (i.e., discounts). The “psychophysics of pricing ” suggests changes in monetary magnitude are not based on their absolute level, but rather on their deviation from some reference level, or how the change is “framed. ” Accordingly, a $5 reduction appears more significant on a $15 purchase than a $125 purchase (Tversky and Kahneman 1981). Often times, however, a promotion is presented in non-monetary terms (e.g., a premium). When two resources are delivered simultaneously, but in different currencies (e.g., receive a free razor with the purchase of a can of shaving cream) the marginal value of the non-monetary, incremental benefit may be difficult to evaluate in relation to the focal product or its price. The value of the premium, therefore, may be less likely

This paper considers whether a particular agent-based stockmarket model is of use in addressing the specific practical issue of how share prices respond to the sale of a large volume of shares. The paper also considers the problems faced in calibrating the model to stock returns found in real markets