Human Psychology Drives Economy Animal Spirits - Essay

  • Length: 10 pages
  • Sources: 50
  • Subject: Economics
  • Type: Essay
  • Paper: #41035034

Excerpt from Essay :

Human Psychology Drives Economy

Animal Spirits - How Human Psychology Drives Economy - the Theory Behavioral Economics Particularly work authors Robert Shiller ( Akerlof) Yale Richard Thaler Chicago. Shiller a web.

The essay is based upon behavioral economics and how human behavior or rather psychology act as an economic driver, thou this theory or opinion hasn't been fully accepted by all economist and authors the essay intends to explore more into behavioral theory or economic and at the end give its own conclusion about the topic.

The essay will first introduce the topic of study then look at some of the economic drivers that have been suggested by other authors and economist to understand more on what an economic driver is. After looking at some of the economic drivers that have been laid out, the essay embarks on the sub-topic which is the theory of behavioral economic in a manner that will draw sharp contrast with the other economic drivers already mentioned and also attempt to introduce the main topic, which is how human psychology drives the economy. The third section will elaborate more on the topic and later the scholarly works of Shiller and Akerlof on whose book the main topic of the essay has been based upon will be looked at. Lastly the paper will be concluded with a verdict on the topic of study.


How human psychology drives the economy is a concept that had been developed earlier by renowned economist known as John Keynes who made significant contributions to the study of economics in general but particular the various theories he had put across on economics phenomena have still a wide used, and also the widely used term in this essay 'Animal Spirit' was first used by him before Shiller and Akerlof among other authors incorporated it into their studies.

Important to note is that the essay has largely referred to the book published recently published by these two successful economists Shiller and Akerlof, which has become a top seller in the United States majorly because it relates; the recent financial crisis to findings in their study.

Economic drivers

According to Benhabib, Jess & Yi Wen (2004) among other authors and economist who have done comprehensive studies on economic development and specifically the key economic drivers and initiatives that enhance such drivers. Through the studies conducted they have been able to compile up a list of economic drivers and initiatives that include; development of new enterprise that would be enhanced by provision of startup finance by the government, technical support and advice to such enterprises, workspaces that would boost new developments and engaging new entrepreneurs in business mentoring programs. Encouraging local investments through financial incentives, provision of aftercare assistance to investors and developing marketing strategies for these businesses act as an economic driver. Thirdly investing in soft infrastructure is also an economic driver, which is initiated by support from the government in terms of research and development, the provision of business advisory services, offering training on skills required, provision of initial finance and capital, supporting trade and business associations and also improving delivery of government services to such business.

The development of local businesses that are already established will drive the economy and this can be done through the government forming exports club for this business to increase their market, providing technical and financial assistance, undertaking business retention surveys and visits, and also encourage initiating campaign that seeks to encourage the public to buy locally manufactured goods. The enhancement of local business environment will also act as an economic driver and it is achieved through reduction of bureaucratic procedures and assisting the councils in conducting customer relations with a view of developing the country's vision. The other viable sector that spurs up economic development is creation of jobs to the unskilled population of the economy by training them on enterprise management, raising educational achievement and developing mentor programs, these would increase their eligibility to get well paying jobs thus increasing their the country's gross domestic product through their contribution.

Lloyd Braga, Teresa (2003) conducted a study that tried to debunk the myth that it is only government's participation that enhances economic drivers and instead came up with a conclusion in their studies that over the past thirty years the key global economic drivers have included; the person computer's evolution, the internet evolution, the rise of capitalism in China and India and the fall of communism in Eastern Europe and also the order of marriage that has been witnessed over the past thirty years whereby learned people marrying amongst themselves and less educated individuals also marry one another. There studies show that these factors have been the economic drivers over the last three decades.

Another study conducted by Mullainathan, & .Thaler, (2001) gave different findings on what are the global economic drivers, their study instead enlisted global economic drivers as; clothing, food, government, shelter, transportation, entertainment, communication, energy, industrial metals and information processing.

All these studies and research carried out doesn't seem to be in consent with one another as they both give divergent opinions on what economic drivers are. And hence this essay tries to explore the theory of behavioral economics and how human psychology drives the economy of any given country.

Behavioral economics theory

The development of behavioral economic theory dates back to the classical period of economic, this according to Camerer, Colin, George Loewenstein, & Matthew (2003).whose studies suggest that moral sentiments theory put forward by economist Adam Smith was the first theory to incorporate psychology with individual behavior, and by 20th century economic psychology was already a well developed topic with the discounted and expected utility been largely accepted as factual as it related decision making with consumer consumption and uncertainty. In the advent of development of cognitive psychology that was in 1960's, behavioral economics theory became widely accepted among many economist as psychologist found relation between one's cognitive and his decision making in circumstances of uncertainty and risk.

Economist and behavior analysts have applied factors such as emotions, cognitive and social factors in behavior finance or economics to explain the economic decisions of institutions and people, they have stated that this factors have an influence on how the two perform economically and their general effect on resource allocation, market prices and returns.

The main aim of behavioral economics theory is to explain how systematic errors such as over or under reaction to any relevant information made available about the market are made by market participants. These errors linked with noise trading, over confidence, limited investor attention and over optimism, negatively affect returns, prices and the general trend in the market thereby creating deficiency in the market. The theory also examines how other market players use these systematic errors to their own advantage.

Benhabib, Jess, Kazuo Nishimura & Q. Meng (2000) used the behavioral economics theory to explain how and why investors make decision to buy or hold on to assets or financial resources and even why they opt to sell their assets. One important observation they made in their study is that the investors are keen to avoid incurring loss and this is a guiding principle when making a decision in selling off some of their assets and they also used this theory to explain why mortgage prices rarely fall even when there is low demand as sellers are wary of making losses.

In their recent book called "Behavioral Economics and its Application," Vartiainen and Diamond have claimed that economist are continually using this theory mostly in the field of development, wage determination, public economics, public economics, health, economics and law, and organizational economics. Furthermore, economists, sociologist and psychologist all have increasingly adopted (Diamond, & Vartiainen. (2007).

Critics to this theory quickly point out that market participants being referred by this theory are rather people who are knowledgeable enough to make well informed decisions, which they base on competition and experience unlike the theory exposes them as people with poor judgmental who end up making systematic errors thereby endangering the whole market. Other critics of behavioral economic theory cite that the theory focuses on decision making thus should only be applied to problems of investor decision rather than be used to explain the general economic behavior. Another notable critic is Cunningham, (2002) who claim that behavioral finance is a made up anomalies and can be viewed as a genuine branch of finance.

'The topic 'Animal spirit: How human psychology drives economy' has largely being built on the theory of behavioral economics.

Human psychology and the economy

The close relationship between human psychology and the economy has been under sharp focus ever since the global financial crisis that was witnessed in the periods of between 2008 to early this year, which had great impact to the economy of United State. This fact inspired books such as "Explaining fiscal foolishness-Psychology and the economy" which is written by Professor of medicine and psychology Peter Ubel of the University of Michigan.

Professor Ubel…

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