Experimental and Behavioral Economics

What is Experimental Economics?

Controlled experiments have been used for many centuries in many observational sciences as a method of inferring causality between two variables, cause, and effect. Economic experiments, however, have just started around the late 1940s and early 1950s, where the first market experiment occurred. Since that time, experimental economics has been gaining growing recognition (as well as criticism) and has established itself. This was highlighted by awarding the Economics Nobel Prize to Vernon Smith in 2002 for establishing laboratory experiments as a method for empirical economic analysis. More recently, Abhijit Benerjee, Esther Duflo, and Michael Kremer won the 2019 Nobel Prize in economics for their application of experimental methods on policy interventions that target poverty.

Just as wind tunnels are used to test new cars or flying objects, in order to see how they interact with the air around them; economic experiments can be considered as wind tunnels to test theory, new policies, and programs. There are three common types of economic experiments: laboratory experiments; lab-in-the-field experiments; and field experiments. BEDMLab's Lab I and Lab III are designed to run laboratory experiments, which are considered the most controlled type of experiments as they offer the cleanest environment (with maximum control of any confounding factors) for testing new ideas. The second type of experiment, lab-in-the-field, is also controlled but it uses participants from the particular population that is being studied (e.g. employees, villagers, or traders). This allows for a more natural environment, but by keeping the clean setting of a laboratory experiment. Lab II and Lab III of the BEDMLab are used for this type of experiment. BEDMLab also provides expertise, guidance, and support on how to run the third type of experiment, which is field experiments. Field experiments are run in completely natural environments, in which participants usually act naturally in an RCT (randomized controlled trial) by varying the variable(s) of interest in order to study its effect on the outcome.

Experiments are used in many fields, including psychology, but what is distinguishing about economic experiments is that they use monetary incentives that are proportional to the performance/outcome of the experiment. Hence, participants have real incentives to make decisions that maximize their utility, and therefore, mimic reality as much as possible. The controlled environment in economic experiments neutralizes the confounding factors (unobserved variables), which occur naturally and can bias the analysis.

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What is Behavioral Economics?

The simplest way to describe behavioral economics is that it treats human beings as humans, with all their limitations, emotions, feelings, constrained knowledge, and, definitely, their psychological biases. Behavioral economics applies psychology to economics, policy, management, and social sciences in order to better understand and predict human behavior.

Traditional economics has long been criticized for failing to explain many phenomena and behaviors because of a systematic bias that stems from the assumption of rationality when modeling human behavior. Behavioral economics does not assume that human beings are irrational; it just assumes that they have bounded rationality that is constrained by the psychological biases they have as humans.

Behavioral economics has been coined as “nudging” people toward better behavior. However, this is an oversimplification of the field, as nudging is only one application of behavioral economics. Behavioral economics is a science that has its methods and techniques, which enable us to analyze and predict human behavior in a formalized manner. It has many applications that go beyond nudging.

As Richard Thaler (father and one of the founders of behavioral economics and also Economics Nobel Laureate, 2017) often says: behavioral economics will soon disappear, as all economics will become behavioral.

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