Prospect Theory

Some corrections from last nights blog...The co-author of Nudge is Richard Thaler & Cass Sunstein.

Robert Shiller is a PhD at Yale.  I have seen him many times on Bloomberg.  He says that the article by Kahneman and Tversky, Prospect Theory: An Analysis of Decision under Risk, (1979) is the most important theory of the last 50 years.  Prospect Theory argues that "decisions deviate from expected utility theory outcome because decision makers are willing to take more risk to prevent losses."  Expected utility theory argues that the rational person is going to make their decisions by weighing the costs and the benefits of a decision and will choose the one that will bring the least pain and the greatest pleasure by making a rational, informed decision. 

In January 2010, Newsweek printed an article called May the Best Theory Win.  This article explains that people, no longer are weighing the costs and benefits but are making irrational choices and thus, the need to propose "a new way of looking at the economy...through the prism of evolutionary biology."  It is proposed that the key is to "craft" a new, unifying theory of economics that can create better policy.  The influence and change agents are interested in combining brain science with economics to map our brain patterns to understand how economic and other decisions are being made.  This definitely will take the guess work out of it.  Now consider Cass Sunstein, which is Obama's regulation czar and is a behavioral economist.  It gives new meaning to what a regulation czar is and what might be the tools of his craft as you consider the changing theory of economics and finance and changing the capitalist system to "adapt" to the New Rational Economics.