[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

nomic model of consumer choice can be used to make accurate predictions. By and
large, it can. Many businesses, for example, have found the model useful for predicting
the demand for their products. And economists have used the model with remarkable
success to predict consumer behavior in a variety of circumstances. Sometimes,
however, it does not make reliable predictions, and we will consider some of these
instances when we discuss behavioral economics.
The second criticism questions the model’s assumption that individuals know what
they like—that is, that they have well-defined preferences. Given a choice between two
bundles of goods—one consisting of two T-shirts and three sweatshirts and the other
containing one pair of jeans and two sweatshirts—they could tell you quickly which they
preferred. Moveover, their answer would be the same tomorrow or next week. But in
many cases, someone asked which of two things is preferred replies, “I don’t know.
Let me try them out.” And what people like may change from day to day. In addition,
their preferences may be affected by what others like. How else can we account for
the short-lived fads so common in food and fashion as well as in other spheres?
The third criticism focuses on the model’s assumption that individuals know
the prices of each good in the market. In fact, people often lack this knowledge.
And even when they know that bargains can be found, it is costly to search for them.
While we can talk meaningfully about the price of a barrel of oil, what do we mean
by the “price” of a couch, computer, or house? If we are lucky and stumble onto a
good deal, we may find a leather couch for $600. If unlucky, even after looking
all day, we may not find one for under $1,000. The ability to search on the Internet
for prices at various stores before we go shopping has helped lower the costs of
finding bargains and has made it easier for consumers to know the prices of goods.
The final criticism points out that sometimes the interactions of prices and preferences
are more complicated than this chapter has depicted. In particular, people’s
attitudes toward a good can depend on its price. More expensive goods may be
attractive simply because they have snob appeal. And when the quality of certain
goods cannot easily be ascertained, people use price as their yardstick. Because, on
average, better (more durable) products are more costly, a cheap item is assumed
to be of poorer quality than its more expensive counterpart. In either case, demand
curves will look quite different from those described in this chapter. Lowering the
price for a good may actually lower its demand.
The need to extend or modify the basic economic model for some goods in some
instances does not detract from its overall utility: in the vast majority of situations,
it provides just the information that businesses and governments need to make
important decisions. Even when it is less effective, the model provides a basic framework
that enhances our understanding of the behavior of households. We will build
on this framework in Part Three. And asking which of its underlying assumptions
may be inappropriate whenever we apply it will help us search for a better model.
BEHAVIORAL ECONOMICS
In recent years, a growing number of economists have combined insights from psychology
and economics to gain new understanding into how people make choices.
Those engaged in this new field, called behavioral economics, reject the simple
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