© Nathan Mandell Daniel Kahneman

Schwartz Memorial Lecture brings Nobel Laureate to Kellogg

by Deborah Leigh Wood

If people always acted rationally, the field of behavioral economics probably wouldn't exist. And Daniel Kahneman might not have been named the 2002 Nobel Prize Laureate for integrating "insights from psychological research into economic science."

Kahneman, the Eugene Higgins Professor of Psychology and professor of public affairs in the Woodrow Wilson School of Public and International Affairs at Princeton University, presented his theories on "Psychology and Behavioral Economics" at this year's Nancy L. Schwartz Memorial Lecture on May 19.

Acting irrationally isn't the same thing as acting stupidly, Kahneman told a capacity crowd in the Kellogg School's Owen L. Coon Forum.

As creatures who favor intuitive and emotional thinking over slower "rational" thinking, we're "adequately successful," Kahneman said.

But we're still irrational. Consider the case of "Bernoulli's error": In 1738, Daniel Bernoulli, a Swiss mathematician, theorized about the decision-making process behind sending a spice ship from Amsterdam to St. Petersburg. The decision to do so (favored by Bernoulli) weighted the endeavor's expected profit more highly than its potential risks. Bernoulli's logic departed from what Kahneman says drives most human behavior: namely, concerns about short-term gains and losses, rather than long-term wealth.

"An entire theory of finance is based on this [flawed] model of risky investment," said Kahneman. "This is bizarre."

Irrational decisions crop up in more mundane circumstances too. People will tend to buy ice cream that's advertised as 90 percent fat-free, Kahneman said, but not when it's advertised as having 10-percent fat. Same product, different psychology. Kahneman's contention is that people are not poor reasoners, but prone to acting impulsively.

At its strongest, irrationality encourages people to take a chance, based on intuition and optimism, and become entrepreneurs, despite knowing the dismal survival rate of start-up firms.

Leaving the audience with a few provocative points, Kahneman asked, "Does behavioral economics still need psychology?" And, more fundamentally, how can demonstrable, meaningful theories about psychology and economics be put to good use?

Kahneman even suggested that much of this theorizing might boil down to good old common sense.

Established in 1983, the annual lecture series, which focuses on issues of current economic theory, honors Schwartz, who was Morrison Professor of Decision Sciences and the first woman faculty member appointed to an endowed chair at the Kellogg School.