Emotion and Economics

The study of economics is based on the rational decisions people make in production and consumption of goods and services, or so it is said.   But economic behavior is like any other human behavior, driven by a psychology that is far more emotional than rational – and it is the emotional aspect that is very often overlooked or pointedly ignored by economists.   The vast majority of economic activity is driven by our emotions.

Every product, be it good or service, is desired for the satisfaction of a need or a want.   But “desire” is an emotional state and the difference between a need and a want is subjective.   The litmus test for a need is to ask if a person can survive without something, and very many of the things we claim to be physical needs are actually emotional desires.

Consider clothing, which is said to be a need because it provides protection from the environment (sunburn and hypothermia).  In temperate climates neither of these needs is valid and even in hostile climates, a person needs only one set of clothing to provide the protection required for survival.  Everything else about clothing is a want – the want to be stylish, the want to avoid having to do laundry daily, etc.   The same can be said for food and drink, as we pay for more quality and quantity than is necessary for survival.  So even our needs are to a great degree wants that address a desire for convenience, esteem, sensual pleasure, or some other non-survival urge.

In terms of human desires, there are fundamentally only two: we wish to maintain our present state or we wish to improve upon it.   Economically, we wish to continue to consume the products we presently consume or we wish to consume something more, something better, or both more and better.   This is the basis of all human desire, hence of all behavior that is undertaken to satisfy desire, hence all economic behavior.

The second factor in economic decisions involves cost.   Everything we wish to obtain must be produced, either by our own effort or that of someone else (who expects payment in exchange for their effort).  The most basic driver of a transaction is the belief on the part of both participants that what they will gain from the transaction is worth more to them than what they have to part with (or undertake) to obtain it.  

This is why economics in a free economy is productive rather than zero-sum: both parties gain something that they value more, for emotional reasons.   When we talk about prices, we speak of them as if it is a balanced equation: that to buy a shirt for twenty dollars means the shirt equals twenty dollars.  But the person who bought the shirt valued it more than twenty dollars, and the person who sold it valued the twenty dollars more than the shirt.   This dual profit is conveniently ignored, and this is the reason economic theories are often surprised by reality.

The relatively new field of behavioral psychology seems to consider this, but in a very superficial and unsatisfactory manner.   If there is to be a school of economics that lends itself readily to application to real-world economic behavior, it must make better account of the emotional side of economics.