Behavioral Economics

Traditional economic theory relies on the concept of the so-called homo economicus, a purely selfish and perfectly rational agent. In recent years numerous empirical studies have shown that this notion of economic agents does not capture economic behavior of humans in the real world. Two important departures are bounded rationality and social preferences: People do not behave perfectly rational, as they often neglect relevant information, and they tend to satisfice, i.e., settle for the second best, rather than optimize. Moreover, people are not fully selfish but care for the well-being of others, and they are usually inequality-averse.

Taking these facets of behavior into account can fundamentally change the positive and normative predictions of economic theories and thus their policy-implications. The aim of this project is to provide new insights into the driving forces of individual economic behavior and to contribute to a better empirical foundation of the economic decision model. Yet, its main focus is on the application of these insights–and insights from behavioral economics at large–to concrete policy questions.

Recent work, e.g., incorporates fairness considerations into an otherwise standard dynamic general equilibrium model and shows that the classical dichotomy (whereby nominal variables have no long-effect effect on real variables) breaks down in an empirically significant and theoretically novel way. Another recent application tests the matching algorithm used by the German central clearinghouse for university admissions in the laboratory. The study shows that a procedure designed to give an advantage to students with excellent school grades actually harms them. The reason is that many students fail to grasp the strategic aspects involved. Future applications will focus, in particular, on the design and implementation of incentives schemes in the labor market and the ensuing consequences for the design of labor market policies.