Yes, this is Economic Psychology! EP1

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A Great Controversy between Two Great Forces
Economists and psychologists are at an impasse! This disagreement is due to different assumptions about human nature, and economic decision-making in particular. Economists generally assume that people are rational, autonomous, utility maximizers, and self-interested (Henrich et al., 2005). However, psychologists assume that we are more irrational, contextually situated, utility compromising, and naturally social (Hoelzl & Kirchler, 2010).

This conflict has developed into a controversy between two constructed prototypes of human nature, i.e. paradigms, which herein are referred to as homo economicus and homo psychologicus. As paradigms, they are both incommensurate, self-defensive, and are vying for power. Both must avoid cherry picking, caricaturing, and other dishonorable reactions (Staley, 1999). Aristotle used to say that truth is located in the golden middle-road between two positions, but such heuristics can also lead to errors if one opts for the median between one big and one smaller flaw.

Why does this matter? It is essential to touch upon this divergence, since it has a great impact on the process of negotiation and cooperation. The issue is that many companies are unaware of the errors in the economist’s model of man, making it propagate costly fallacies, and stay strategically undifferentiated from the competition. We can identify various points on which economics and psychology differ, which corroborate the ones introduced above. An economist views the world through googles where everything has a monetary metric as referent, while psychologists instead see thoughts thus superimposed; i.e. economics is reductionist while psychology is more holistic. Level of analysis is also a point of departure, with economists focused on the macro- and psychologist on the micro-level. Even gender issues might play a role, in that women are overrepresented in psychology programs, while males are likewise in economics (Moakler & Kim, 2014; Zafar, 2013).

On so many levels, economics and psychology seem antithetical. Yet, due to deficiencies in both, a new field arose which presents economics and psychology as a Venn diagram where the overlapping area is the domain of economic psychology. Still, paradigmatic tensions abide. A big deficiency in economics is its inability to prevent financial crises/defaults on the micro- and macroeconomic level. This has made it more introspective and self-critical, with various academians remunerating whether they have played a role in propagating detrimental ideas and creating self-fulfilling prophecies (Ghoshal, 2005; W. Long, Malhotra, & Murnighan, 2011).

Psychologists have thence ushered in to use their models of human behavior, in order to explain why these issues arise and how we can prevent them: increasing predictive validity on various economic phenomena. The psychology of the marketplace is however not a completely alien topic, but rigorous scientific findings on the bounded nature of our rationality has made psychology’s role more credible. Our brain process information either fast (intuitive/system 1) or slowly (rational/system 2), and the former applies heuristics, biases and emotions to speed up the process (D. Kahneman, 2012). We simply do not have the mental capacity for a close analysis 24/7, but the disturbing thing is that system 1 can be in the driver seat during critical corporate decision-making; like e.g. a manager “in love” with an idea.

The economicus/psychologicus conflict often manifest itself in the workplace. The departments with most conflicts are Finance and HR, with the former questioning the financial value of the latter, and the latter thinking the former are little more than bean-counters (Cascio & Boudreau, 2011). Some (Towers Watson & Forbes Insights, 2011) argue that there will be a tighter cooperation between Finance and HR in the future, and it is hence important to have a hybrid perspective in the form of economic psychology.

Food for Thought! How rational is decision-making in your company?

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