Psychology and the Market

Edward L. Glaeser

NBER Working Paper No. 10203
Issued in January 2004
NBER Program(s):   LE   AP   PE

Prospect theory, loss aversion, mental accounts, hyperbolic discounting, cues, and the endowment effect can all be seen as examples of situationalism -- the view that people isolate decisions and overweight immediate aspects of the situation relative to longer term concerns. But outside of the laboratory, emotionally-powerful situational factors -- frames, social influence, mental accounts -- are almost always endogenous and often the result of self-interested entrepreneurs. As such, laboratory work and, indeed, psychology more generally, gives us little guidance as to market outcomes. Economics provides a stronger basis for understanding the supply of emotionally-relevant situational variables. Paradoxically situationalism actually increases the relative importance of economics.

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Published: Glaeser, Edward L. "Psychology And The Market," American Economic Review, 2004, v94(2,May), 408-413.

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