In most respects, economics is a social science, alongside psychology and sociology then it is a "natural" science such as chemistry and biology. Economics (particularly microeconomics) is ultimately concerned with why, when, and how human beings trade with each other. Different schools of thought have taken the field toward increasing levels of mathematical sophistication and model-based regression forecasting, but the building blocks continue to be human actors and their behaviors.
- Economic theory tries to understand human action as it relates to prices, markets, production, and consumption.
- Mainstream economic theory rests on "laws" like supply and demand, and assumptions that include rational actors and efficient markets.
- Behavioral economics and other strands of thought understand the emotional and cognitive underpinnings of economic behavior.
Supply & Demand
Consider the laws of supply and demand in economics. When placed on a microeconomic chart, it looks as though price is determined through a mechanical adjustment based on the quantity of a product and the number of buyers in the market. In reality, a price is the agreed-upon level at which a seller is willing to part with a good and the buyer is willing to assume it. Consumers have to compete with other consumers when bidding for a good. Producers have to compete with other producers for those consumers. It's the actions of individual actors that determine economic reality—not the other way around.
The field of economics attempts to understand the patterns of individual decisions within the context of a world that has scarce resources.
Human Action and Determining Value
Economic actors will regularly engage in transactions that they anticipate will make them better off. If a consumer buys a loaf of bread for three dollars, they are implicitly stating that they value the bread more than three dollars. The seller, by offering the loaf for three dollars, is implicitly stating that the three dollars are more valuable than the bread.
Presumably, the general market for bread in the area suggests that three dollars are an acceptable price to entice businesses to become bread retailers and assume the associated risks. This also means that wheat farmers are sufficiently compensated, transportation is economically feasible and hundreds (if not thousands) of other human actions can be coordinated in a sustaining way.
Each actor in the chain of financing, production, and consumption is receiving enough value to entice their cooperation. To save time, economics studies the price rather than breaking down every single trade, transaction, and motivation. The root is a huge series of human value judgments and behaviors. The price, in a sense, economizes on the information.
Analyzing and Understanding Human Behavior
Economics appears to be superficially concerned with abstractions such as demand curves, production possibilities frontiers, or interest rates. None of those inputs actually exist in a tangible sense. However, the root is always individual human action. Every actor is simultaneously coordinating his activities in a meaningful, value-driven way. Those values and actions are dynamically captured through broad economic indicators and subsequently analyzed.
Human action cannot be predicted with any certainty. No economist knows how much any single consumer will be willing to pay for a 50-inch television in 2024, for example. A basic understanding of human action can help economists identify meaningful tendencies in resource allocation, however.
Behavioral economics draws instead on psychology and economics to explore why people sometimes make irrational decisions, and why and how their behavior does not follow the predictions of economic models. Decisions such as how much to pay for a cup of coffee, whether to go to graduate school, whether to pursue a healthy lifestyle, how much to contribute towards retirement, etc. are the sorts of decisions that most people make at some point in their lives. Behavioral economics seeks to explain why an individual decided to go for choice A, instead of choice B.
Because humans are emotional and easily distracted beings, they make decisions that are not in their self-interest. For example, according to the rational choice theory, if Charles wants to lose weight and is equipped with information about the number of calories available in each edible product, he will opt only for the food products with minimal calories. Behavioral economics states that even if Charles wants to lose weight and sets his mind on eating healthy food going forward, his end behavior will be subject to cognitive bias, emotions, and social influences. If a commercial on TV advertises a brand of ice cream at an attractive price and quotes that all human beings need 2,000 calories a day to function effectively after all, the mouth-watering ice cream image, price, and seemingly valid statistics may lead Charles to fall into the sweet temptation and fall out of the weight loss bandwagon, showing his lack of self-control.