May 25, 2024

1. Behavioral Economics

Psychologist Daniel Kahneman was awarded the Nobel Prize in Economics in 2002 for “his view of economics from the perspective of psychology, and in particular the way people make decisions in the face of uncertainty”. Kahneman’s research revealed that people do not always rationally consider their self-interest, contrary to the expectations of the maximization of expediency theory. This groundbreaking concept also became the basis for the field of study called behavioral economics. Kahneman conducted this work together with Amos Tversky, but Tversky did not receive the award because he passed away in 1996 (according to Nobel rules, posthumous awards cannot be given).

The duo identified general cognitive biases that drive people to make irrational decisions. According to the duo, the three most important prejudices that push people to make irrational decisions are anchoring effects, planning errors, and the illusion of control. The duo’s article “Prospect Theory: An Analysis of Decision under Risk” (not translated into Turkish) is one of the most cited articles in the field of economics. Prospect theory, which earned Kahneman the Nobel Prize, examines how people make decisions in the face of uncertainty. We tend to follow irrational paths, such as perceived human fairness and avoidance of loss. For example, while we try hard for a small discount on a small purchase, we may choose not to claim the same discount at all for a larger purchase.

Kahneman and Tversky’s work also reveals that people can use general rules such as representativeness to make irrational decisions. For example, when a woman who is afraid of discrimination is defined and asked whether this woman is an ordinary bank clerk or a feminism activist, people generally think of the second option; whereas, according to the laws of probability, the woman in question is more likely to be an ordinary bank teller.

2. Managing Commonly Used Resources

Elinor Ostrom, a professor of political science at Indiana University, became the first woman to receive the Nobel Prize in Economics in 2009. His research that brought him the award was “economic management of common resources”. The research examined how groups of people manage common resources such as water resources, fish and lobster reserves, and pastures. With this work, Ostrom proved that Garrett Hardin’s “tragedy of the commons” theory is not destiny.

According to Hardin’s theory, in order not to run out of common resources, they should be placed under the control of the state or private companies, because each individual would want to get the maximum benefit from the common use area. Ostrom showed that if there are relationships between individuals and the group in question is physically close to the resource in question, that resource can be managed in the most efficient way for the community, without the need for any control mechanism. According to Ostrom, these control mechanisms would have managed that resource much more inefficiently, since it did not fully know the conditions of the environment in which the resource is located and the norms of the society using it; the community using the resource would protect that resource and provide self-control within its own rules.

To learn more about Ostrom’s work, refer to his 1990 book “Governing the Commons: The Evolution of Institutions for Collective Action” (not yet translated into Turkish), or “Revisiting the Commons: Local Lessons,” published in Science Journal in 1999. You can refer to his article titled “Global Challenges” (not yet translated into Turkish).

3. Public Choice Theory

James M. Buchanan Jr. won the Nobel Prize in Economics in 1986 for “developing the theory of the contractual and constitutional basis of economics and political decisions.” Buchanan’s greatest contribution to public choice theory was the evaluation of the effect of public choice on the decisions taken by the public sector in the light of economics and political sciences. According to the data revealed by Buchanan, officials who are called “public officials” and who are expected to make decisions in the public interest are more likely to make decisions based on their own interests, just like in the private sector. Buchanan describes his theory as “politics without romance.”

Using Buchanan’s theory based on the political process, human nature, and free market factors, we can identify the factors that motivate political actors, so we can better predict what policy decisions will be made. These insights can be used to make decisions that are more in the best interest of society. For example, we can reduce the cases such as budget deficits, which elected public officials do not hesitate to make in order to get more votes, by limiting government expenditures, thus reducing the tax burden on citizens.

Buchanan wrote The Calculus of Consent: Logical Foundations of Constitutional Democracy in 1962 with Gordon Tullock, for which he won the Nobel Prize.” In his book (not translated into Turkish), he describes his views in detail.

4. Game Theory

Awarded the 1994 Nobel Prize in Economics, John C. Harsanyi, John F. Nash Jr. and Reinhard Selten’s work was “Analysis of equilibrium in the theory of uncooperative games”. The non-cooperative games that these three scientists are working on are part of a wide-ranging theory we call “game theory.” Non-cooperative games are games in which the participants do not make binding agreements. Each participant bases their moves only on their own predictions, without knowing how the other participants will act.

Nash’s greatest contribution to this theory is the so-called “Nash Equilibrium”, which is used to predict the outcome of non-cooperative games. The famous scientist’s doctoral thesis of 1950, “Games without Cooperation”, gives the details of this balance. Nash Equilibrium digs deep into previous years’ research on two-player, zero-sum games. Slten made great contributions to economics by applying Nash’s findings to dynamic strategic interactions, and Harsanyi applying incomplete information scenarios. The contributions of these three scientists are applied in economic fields such as the analysis of olipology and industrial organization theory, and even inspire new fields of study.

5. Asymmetric Information

George A. Akerlof, A. Michael Spence and Joseph E. Stiglitz won the Nobel Prize in Economics in 2001 for their work on “analysis of markets with asymmetric information networks”. According to the trio’s findings, economic models built on a perfect network of information are often wrong, because in any economic transaction, one party has more information than the other. This is called “asymmetric information”.

Understanding the phenomenon of asymmetric information allows us to better understand how some markets work and to realize how important the transparency of companies is. To explain asymmetric information, Akerlof used a market where sellers know much more about the quality of products than buyers do, so sales of defective products are common (which he calls “adverse selection”). For more detailed information, you can refer to his 1970 article “The Market for ‘Lemons’: Quality Uncertainty and the Market Mechanism” (not translated into Turkish).

Spence’s research focuses on signaling, the data that more knowledgeable market participants can provide to less knowledgeable participants. For example, the educational background of a young employee applying for a job in a company is called a signal to show how productive he will be in the company, or to distribute dividends to shareholders to show the profitability of a company .

Stiglitz, the last of the trio, showed that insurers will use different combinations of deductibles and premiums to understand which customers have the greater risk potential (he called the process “monitoring”).

These concepts are so common today that many of us take them for granted; but when these concepts were first introduced, they were seen as groundbreaking methods.

While we conclude our article, let’s not go without saying that; There are many more economic theories that have been awarded the Nobel Prize in Economics, handed out since 1969, and they are all worth checking out. But the five theories we’ve listed here are the ones that you can use in your daily life and are likely to come across frequently.

Finally, we recommend that you take a look at our similar publication, which contains very important lessons from the world’s most important economists such as John Maynard Keynes, Adam Smith and Max Weber.

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