How does psychology play a role in economics?
I am currently researching macroeconomics and am curious on something.
When considering the the great crash of 1929 a lot of banks went under due to the public withdrawing all of their funds until the bank was left with nothing in cash and zero customers. After that point what is the bank left to do? Close. And was a lot of their effort an action thanks to the media and word of mouth?
I propose this question; what if the public left the worries, proposed by the public, of the bank failing out of their minds or didn’t react in such a way that would drain the bank’s cash? Rather, educated themselves on the facts of the banks health and likewise with the economy. Would the banking industry, in response, not fail or at least not take such a negative hit?
If “bad” or “negative” news regarding the stock market or banking industry on a main network in broadcast on a Monday night; how many people, immediately on Tuesday, rush to the bank and withdrawal their funds, or sell their stock?
The questions above bring me, more specifically, to my reason for this post and my specific question. How much of an effect on our markets do uneducated, psychologically-emotional-driven decisions have?
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7 Answers
Economists rely on psychological studies for certain of their data.
In my opinion, the answer would be: little.
Uneducated, psychologically driven investors don’t hold that amount of money to cause significant shocks in the system. Psychology can amplify some aspects of the cause-effect matrix, but I believe traditional economic assumptions still represent accurately the ‘pond’ perimeter in which all of us, little fishes, swim with our own peculiar behavior.
Trading is all about psychology. Traders know that people will follow a trend, and they specializing in hopping on the trend at the beginning and getting out just before the crash. I’ve heard a few studies about the impact of psychological factors in markets, but I don’t remember what they said.
In any case, the economy is made up of billions of individual choices. To get at the major trends, you have to understand the underlying psychology. Psychology is all about that.
Take a look at behavioral economics.
But I would fault your premise -the panic of a bank run is rational if there is a risk the bank will close and you won’t have access to your money. If that is a real risk, then you want to be the first in line to make sure your money is in your hands. So individually rational decisions lead to a collective catastrophe. That is why we now have FDIC insurance on bank deposits. But you see the same boom and bust with stocks and other markets for similar reasons.
A bank run is often the result of the fact that the bank already is running low on reserves. Banks can actually fail without a run on them, so before FDIC people could lose out by not withdrawing their funds. Also, bank runs didn’t happen much in 1929, most of them came later fyi.
Psychology is very strong in economics. Check out the work on Neuroeconomics and Picoeconomics for understanding these issues if you are really interested. The behavioural economics literature is quite varied.
To answer your specific question, greed is the driving force behind most decisions on wall street and banking. How they get what they want is certainly not conducted by uneducated individuals, in most cases, the people that have fleeced us are highly educated and very well connected, and worst yet, they are not done yet.
Psychologists determine how to advertise or market focus based on everyones needs.
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