Understanding the Real Economy through Behavioral Economics

Generally, criticism on economics can be summed up largely in two ways. One is the uncertainty of prediction. Uncertainty increases in economy on account of many related variables. The other is doubts about economic activities and economics. Classical economics assumes that every human being thinks reasonably. But reasonability presupposed in classical economics involves a gap between the unrealistic premise and economic activity resulted from that. In other words, economics is based on the notion of the best and the second best. The best is the area where perfect competition comes into existence. In perfect competition, it is presupposed that all humans are reasonable economists and are equipped with information (the completeness of information). This assumes that it is possible to predict the future exactly (certainty) and either consumers or suppliers are not influenced by price. When this kind of perfect competition comes into existence, classical economics plays crucial roles in the market mechanism. On the contrary, the second best is the case that perfect competition does not come into existence. The typical example of the second best is information economics like the asymmetry of information or incomplete contract theory. This applies to how the government should intervene with the area where consumers are not equipped with complete information, for instance, medicine or caring. Behavioral economics or game theory is also applied to the second best. Considering the winners of the Novel Prize in Economic Sciences, we can see that neoclassicists (the best) were dominant in the past while the second best is increasing recently. Those having doubts about the market mechanism show keen interest in the second best economics. To understand a complex society, it is needed to have wisdom for explaining things or phenomena briefly within the extreme presupposition of economists. Behavioral economics can explain unreasonable behavior that classical economics has failed to explain.