The Foundations of Behavioral Economic Analysis

Citation

Dhami, S. (2016). The Foundations of Behavioral Economic Analysis. Oxford University Press.

Chapter Summary

This is a single-author treatise of roughly 1,750 pages, divided into nine parts and 24 chapters, with an introduction at the front and an appendix on game theory at the back. The publisher presents it as an introduction to behavioural economics for advanced undergraduate and postgraduate students that guides the reader through theory and evidence, with applications throughout. In the early parts the contents show a recurring pattern: a part introduction, a chapter on the evidence for the topic, then chapters on behavioural models and their applications.

Introduction

The introduction (about 75 pages) comes before Part I and sets up the subject and the book's approach.

Part I: Behavioral Economics of Risk, Uncertainty and Ambiguity

Chapters: The Evidence on Human Choice under Risk and Uncertainty; Behavioral Models of Decision Making; Applications of Behavioral Decision Theory; Human Behavior under Ambiguity. The part examines the evidence against expected utility theory and outlines the behavioural response, in which prospect theory is described as the best empirically supported theory. It then turns to ambiguity.

Part II: Other-Regarding Preferences

Chapters: The Evidence on Human Sociality; Models of Other-Regarding Preferences; Human Morality and Social Identity; Incentives and Other-Regarding Preferences. The evidence comes from experimental games on sociality. The models and applications include inequity aversion, intentions-based reciprocity, conditional cooperation, human virtues and social identity.

Part III: Behavioral Time Discounting

Chapters: The Evidence on Temporal Human Choice; Behavioral Models of Time Discounting; Applications of Present-Biased Preferences. The part sets the evidence against the exponential discounted utility model beside behavioural alternatives such as hyperbolic discounting, attribute-based models and reference time theory.

Part IV: Behavioral Game Theory

Chapters: The Evidence on Strategic Human Choice; Models of Behavioral Game Theory. The first chapter reviews evidence on classical game theory. The models include level-k and cognitive hierarchy models, quantal response equilibrium and psychological game theory.

Part V: Behavioral Models of Learning

Chapters: Evolutionary Game Theory; Models of Learning; Stochastic Social Dynamics. The publisher lists evolutionary game theory, classical models of learning, the experience-weighted attraction model, learning direction theory and stochastic social dynamics.

Part VI: Emotions

Chapters: Emotions and Human Behavior; Interactions between Emotions and Cognition. Topics include projection bias, temptation preferences, happiness economics and the interaction of emotions with cognition.

Part VII: Bounded Rationality

Chapters: Judgment Heuristics; Mental Accounting; Bounded Rationality in Financial Markets. The three topics are judgement heuristics and biases, mental accounting and behavioural finance.

Parts VIII–IX: Behavioral Welfare Economics; Neuroeconomics

Part VIII covers behavioural welfare economics, with soft paternalism and choice-based measures of welfare as the main topics. Part IX is an abbreviated taster course in neuroeconomics. An appendix on game theory follows, then indexes of named authors and subjects.

Key Concepts

Parts I–II

• Prospect theory: the best empirically supported behavioural alternative to expected utility theory, according to the publisher.
• Ambiguity: choice when probabilities are not known, the subject of its own chapter.
• Inequity aversion and intentions-based reciprocity: models of other-regarding preferences.
• Social identity: the group-based element of preferences covered with human morality.

Parts III–V

• Present-biased preferences and hyperbolic discounting: behavioural departures from exponential discounting.
• Level-k and cognitive hierarchy models; quantal response equilibrium: behavioural models of strategic choice.
• Experience-weighted attraction; learning direction theory: models of learning from experience.
• Evolutionary game theory and stochastic social dynamics: approaches to the long-run evolution of behaviour.

Parts VI–IX

• Projection bias and temptation preferences: emotion-related departures from the standard model.
• Judgment heuristics, mental accounting, behavioural finance: the three bounded-rationality topics.
• Soft paternalism: the policy stance considered under behavioural welfare economics.

Critical Analysis

Strengths

• Systematic coverage. The nine parts run from decision theory through social preferences, time, strategic interaction, learning, emotions and bounded rationality to welfare and neuroeconomics. The publisher's synopsis states that evidence and models are presented together for each topic.
• Consistent structure. Where the pattern holds, a part begins with the evidence and then presents models and applications, which makes it easy to enter at a part and to compare behavioural models with the standard ones they modify.
• Game-theoretic foundations included. An appendix on game theory and the treatment of classical game theory at the start of Part IV let readers review the benchmark before the behavioural models.
• Modularity. Because the parts are organised by topic, a reader can go straight to one of them, and Oxford later issued parts of the material as separate volumes, such as the volume on bounded rationality (2020).

Limitations

• Length. At about 1,750 pages the book is closer to a reference than a course text, and a semester course must select parts. The 2016 single-volume edition predates the separate volumes.
• Formal treatment. The synopsis describes the models behind each topic as well as the evidence, so readers need to be comfortable with formal economic models; the game theory appendix helps those who need a refresher before Part IV.
• Some areas are only sampled. The publisher describes Part IX as an abbreviated taster course in neuroeconomics, so readers wanting depth there need other sources.

Where It Fits in the Course

Within the behavioural economics list, this is the comprehensive graduate-level reference. Baddeley's Behavioural Economics: A Very Short Introduction and Thaler's Misbehaving are accessible first reads, the second being a first-person account of how the field developed. Wilkinson and Klaes's An Introduction to Behavioral Economics and Cartwright's Behavioral Economics are textbooks that set the main findings or models beside the evidence, and they are sensible steps before this one. Camerer, Loewenstein and Rabin's Advances in Behavioral Economics is an edited collection of influential articles with a long survey essay; Dhami's parts give a systematic, single-author treatment of topics of the kind those articles address.

Read the shorter texts first for orientation, then use Dhami for the chosen topic in depth.

How to Use This Book

The publisher aims the book at advanced undergraduate and postgraduate students. Intermediate microeconomics and calculus are sensible prerequisites, and some game theory helps for Parts IV and V; it is also useful to researchers who want a single reference.

A practical plan:

• Core: the introduction and Part I, on risk and prospect theory, then Part II on social preferences and Part III on time discounting, since they open the book and cover its first three topics.
• Strategic topics: Part IV, after reviewing the appendix on game theory; Part V adds learning.
• Selective: Parts VI to IX according to interest, for example Part VII for readers in finance.
• Method: for each part, read the evidence chapter first, then the models, and finish with the applications. Do not attempt the book front to back.