Although the first Nobel Prizes were awarded in 1901, the Nobel Memorial Prize for Economic Sciences originated in 1969. An Israeli professor from Princeton University, whose groundbreaking economic theories are based on analysis of human behavior, was one of two scientists to win the 2002 Nobel Memorial Prize for Economic Sciences when the prizes were awarded Oct. 9.
Daniel Kahneman, 68, who also holds U.S. citizenship, and Vernon L. Smith, 75, of George Mason University in Virginia will share the $1 million prize, which they received in recognition for their pioneering use of psychological and experimental economics in explaining decision-making and behavior of financial markets.
Kahneman was born in Tel Aviv in 1934. He received his B.A. in mathematics and psychology from Hebrew University in Jerusalem and his doctorate in psychology from the University of California at Berkeley. Since 1993, he has been the Eugene Higgins Professor of Psychology and Professor of Public Affairs at Princeton.
Kahneman has integrated insights from psychology into economics, “especially concerning human judgment and decision-making under uncertainty,” the Royal Swedish Academy of Sciences said in its citation. His experiments in probability theory showed that experts are often shortsighted in interpreting data that could explain large fluctuations in financial markets and other phenomena that elude existing models, the academy said.
In praising the research, the Academy explained that traditionally, “much of economic research has relied on the assumption that (the economy) is motivated by self-interest and capable of rational decision-making.” Economics has traditionally been widely considered a non-experimental science, relying on observation of real-world economies rather than the controlled laboratory experiments that are the purview of Kahneman and his associates.
Kahneman’s main findings concern how human decisions may systematically depart from those predicted by standard economic theory. He has formulated so-called prospect theory as an alternative that better accounts for observed behavior.
Prospect theory says that people aren’t as calculating as economic models assume. Instead, people repeatedly make errors in judgment that can be predicted and categorized. An important insight into their work was that people are averse to recognizing their losses, a point that helps explain stock market behavior.
In investigating market mechanisms, Kahneman found that people act asymmetrically when buying or selling. In his words, if an individual has a cup of coffee and has an opportunity to sell the cup, the minimum price he will ask for the cup will be higher than the maximum price would be willing to pay for the same cup if he didn’t have one like it. In other words, the individual’s preference depends on the circumstances, and not only on the available opportunities. This contradicts a fundamental assumption of the theory of consumer behavior.
In addition, Kahneman attacked another basic assumption that stated that firms react to changes in demand by appropriately raising or lowering prices. Kahneman found this was not so: while firms raise and lower prices when faced with profitability problems, they do not quickly exploit these changes in the market.
His explanation for their apparently irrational behavior was that people perceived such exploitation as unfair. He concluded that business firms take social norms of fairness into account, and therefore did not behave as economic theory predicted.
Past Nobel awards in economics have recognized research on topics ranging from poverty and famine to how multinational corporations reap profits, and theories on how people choose jobs and the welfare losses caused by environmental catastrophes.
The medicine, physics, chemistry, literature and peace prizes were established in the will of Alfred Nobel, the Swedish industrialist and inventor of dynamite, and were first awarded in 1901.
The Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel was established separately in 1968 by the Swedish central bank, but is grouped with the other awards. It was first awarded in 1969.
The 2002 prizes will be presented to the winners Dec. 10, the anniversary of Nobel’s death in 1896.