The Nobel Prize for Economics. Big Ideas.

The Nobel Prize for Economics has been awarded 44 times. At first glance it can seem that some of these concepts are only for academics but these ideas can apply to everyone. Some of these economic theories have even changed how we view the world today. By having a basic understanding of these concepts it can benefit us on a day to day basis as the world evolves at an alarming rate due to the accessibility to information that the internet has granted us, and has in turn revolutionized ordinary people’s access to all types of resources that formerly only granted to the privileged few. Companies like CMC Markets provide online tools for anybody to get involved with investing in financial markets and spread betting. In this brave new world of possibilities, these concepts are more relevant to our daily lives than ever before.

Game Theory

All in all, eleven ‘game theorists’ have won the Nobel Prize for Economics. In 1994 the prize went to John C. Harsanyi, John F. Nash Jr. And Reinhard Selton for their work in this field. Game theory is concerned with human decision making and how within the confines of ‘non – cooperative games’ decision making is based on a participants prediction of the behaviour of their opponent without certainty on how they will behave. The idea also incorporates an assumption that if one opponent makes a bad decision the other participant can capitalize on that forming a kind of equilibrium. One’s loss is the others gain. These ideas have become a cornerstone of modern economics and sparked further research in many different areas including the development of the theory of industrial organization.

Public Choice Theory

In 1986 James M. Buchanan Jr. Received the prize for his work in this area of economic theory. His work combines ideas from politics and economics that surround the motivation of public figures like politicians and bureaucrats. The idea that these public figures, many of whom are voted into power and hold public office with the intention that they fulfill a public duty are acting in the public interest is challenged here. Buchanan set out to prove that these officials are often acting in their own best interests just as they would in the private sector. He called this misconception ‘the politics of romance.’

Asymmetric Information.

This economical theory is concerned with how the inequality of information available to players within a market can create a market that contains ‘lemons’ George A. Akerlof, A. Michael Spence and Joseph E. Stiglitz won the Nobel prize in 2001 with their work in this area. Akerlof used the used car market as an example of how the discrepancy between the knowledge of the seller and the knowledge of the customer can create a situation where the customer unwittingly buys an inferior product or ‘Lemon.’

Spence expanded upon this idea by concentrating on how better-informed market participants can inform customers with less knowledge.Stiglitz took this idea even further using insurance companies as an example of how customers can be assessed or screened by being offered different product choices. If the insurance company offers different options to the customer, a choice of premiums and deductibles the company can infer as to the knowledge of that customer.. A practice that we now take for granted but that was ground breaking at the time.

Management of Common Pool Resources.

In 2009 Elinor Ostrom became the first female recipient of the Nobel Prize for Economics for her work in this area. Her work centered on economic governance with particular reference to the House of Commons. The previous prevailing theory had been Hardin’s theory of the ‘tragedy of the Commons.’ The idea that government or private ownership of assets divided into lots was the best way to maximize distribution of resources as this control would help the resource from being depleted through over use. Challenging this idea Ostrom went on to show that common community control of assets can work and is often the best way to manage resources.If those in control have a close relationship to both the asset in question and each other then their superior knowledge of the resource and their wish to fairly distribute it can make them the best choice for management over a government agency that may have less local knowledge or understanding of the needs of the community involved.

Behavioral Economics

The 2002 Prize was won by psychologist Daniel Kahnerman with his work again concerning human decision making. He aimed to show that people do not always act out of rational self-interest as the previously accepted theory of expected utility maximization would predict. Daniel Kahnerman worked with Amos Tversky in this research.They wrote an article ‘Prospect theory: An Analysis of Decision Under Risk’ to explain how people really make decisions. He showed that people will expend more effort to save the same amount of money off a small purchase than a larger one. Even though the amount is exactly the same, the proportion of the purchase as a whole means that irrationally we value the discount more with the smaller purchase. He explains that emotional responses play a larger role in our decision making than we would expect with irrational reasoning coming into play such as perceived fairness and loss aversion. This leads us to make questionable decisions and gives us the illusion of control. It is easy to see how this theory in particular can help us to look at our own reasoning when addressing financial matters.

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