This chapter brings together the neglected pre-1980 “behavioral theory of the firm” and the Marshallian resource-based or capabilities-based evolutionary approach to the firm to analyze the drivers of efficiency and productivity in organizations. It begins with Leibenstein’s X-efficiency view of why firms differ in their costs and then adds a dynamic perspective by considering the growth of knowledge view of the firm offered by Marshal and Penrose, which emphasizes the role of managerial learning, before introducing the learning curve concept. The focus then moves to the consequences of employment contracts being loosely specified and managers having to earn their authority by how they operate. This leads in turn to the behavioral view of organizations as shifting coalitions of stakeholders who are trying to pursue diverse subgoals, which may result in firms earning smaller profits that would have been possible and in the accumulation of “organizational slack.” Finally, the chapter discusses the impact of (sometimes highly dysfunctional) corporate cultures – i.e., the operating systems of formal and informal rules that firms use – in shaping their productivity and ability to change.

Search for solution to problems inherently entails a problem of allocating attention in the face of uncertainty. It therefore requires the use of aspiration-based satisficing or other (dysfunctional or fast-and-frugal) heuristics and stopping rules to close off open-ended choice problems. In discussing the orthodox notion of optimal search, we end up concluding that it is logically deficient if applied to open-ended problems. Moreover, heuristic-based methods may be more effective means than lengthy deliberation for gathering information on which to base decisions – though it is shown how using heuristics can sometimes prove to be a dysfunctional way of navigating complex information environments. These issues are explored especially in relation to the challenges of choosing mobile (cell) phone connection contracts, filling job vacancies and finding marriage partners, with a focus on what is “procedurally rational,” i.e., contextually appropriate deliberation. The chapter’s analysis of shortcut search methods includes the role of market institutions, goodwill relationships and creative thinking, along with the use of heuristics for dealing with source credibility issues.

This chapter sets out the methodology of the approach to behavioral economics developed in this book, emphasizing its rejection of the static “as if” approach of conventional economics and the latter’s view of rationality. It introduced the idea of a decision cycle (problem recognition, search, evaluation, choice, implementation and hindsight review), while emphasizing that how decisions are taken depends on their context. This leads to a pluralistic analysis where alternative perspectives share the idea that everything we do is based upon systems of operating rules and routines. The chapter explores the research methods of behavioral economics, including the roles of anecdotes, introspection, textual sources, questionnaires, experiments and computer simulations. Before closing by outlining the rest of the book, it introduces the evolutionary economics and evolutionary psychology perspectives that are closely related to the pre-1980 approaches to behavioral economics and kept building upon them after 1980 when behavioral economics was refashioned by Thaler with a focus on “heuristics and biases” that took the conventional approach to economic rationality as its reference point.

This chapter brings together ideas from earlier chapters on decision-making and integrates them with perspectives from evolutionary economics to analyze the process of structural change. It begins with a neo-Marshallian view of the competitive process and price setting in a mature industry, which is then extended to consider how selection processes work when an industry is disrupted by customers switching to different products or the uptake of innovative production systems. This leads to a view of industries as being akin to sporting leagues in which the winners can increasingly dominate unless new entrants or less-successful firms can fight back despite smaller profits by rewriting the rules of the game. The uptake of new concepts is analyzed via Dopfer et al.’s “micro–meso–macro framework,” in which a “meso” is a generic concept that firms apply in different “micro” ways, often triggering much wider “macro” changes (e.g., impacts of smartphone apps) but where adoption can be delayed by deal-breaker issues with initial versions and other sources of resistance to change. Finally, the chapter examines how shifting corporate politics shapes how bold firms are in making innovations and how the changing distribution of knowledge in an industry affects the division of labor between firms.

This chapter examines alternative view of how people choose once they have construed what their options offer. It includes critical assessments of one-size-fits-all models from psychology (the Fishbein-Ajzen model of behavioral intentions, which takes account of social pressure, and Prospect Theory, which Thaler popularized in economics) that entail weighing up strong and weak points to arrive at an overall value for each option (“compensatory” choices). However, it suggests these are better seen within a pluralistic, context-based view of choice in which, in some situations, choices are made in intolerant ways based on a checklist or list hierarchically ranked requirements (“non-compensatory” choice) or are made via much simpler decision rules. These different ways of choosing are considered in relation to Chapter 7’s analysis of value systems and that framework is used to analyze how dilemmas are resolved. Differences between choice methods in the role they assign to prices are considered, along with the psychology of pricing and how the use of decision rules reduces challenge of predicting buyer behavior. Case studies are used to show how contexts affect how choices are made.

This chapter questions whether evolution would have resulted in people inheriting the kinds of preference systems that economists normally assume, whose generic form offers little to explain responsiveness to price changes or what people mean if they say they “don’t like” something or “wouldn’t change for the world.” The chapter fills these gaps by exploring the relationship between cognitive rules and operating systems, emotions and values, via a novel extension of Kelly’s personal construct psychology, means-end-chain analysis, Hayek’s theory of the mind and the notion of brain plasticity, with the resulting synthesis providing foundations of the core modern behavioral notion of loss aversion as well as showing how people can change their minds through time even though they may have trouble accepting some new situations. This analysis centers on the complex cognitive architecture of the systems of thinking and neural networks that people build to make sense of the world, where change in one area may require collateral change elsewhere and the mind favors options that limit the amount of cognitive restructuring necessary to prevent reductions in its ability to make sense of the world.

In addressing the question of how firms and governments can seek to manipulate behavior, this chapter considers a wider range of perspectives than the “Nudge” approach popularized by Thaler and Sunstein and the “Boost” approach that has recently focused on enhancing decision-making skills rather than on exploiting “supposedly irrelevant factors” that make consumers “predictably irrational.” It thus covers how shopping mall and in-store shopping environments are designed to divert attention to keep shoppers shopping via the “Gruen transfer” process. The chapter also covers the use of product-proliferation strategies aimed at creating “confusopoly” markets and devious strategies such as teaser offers and the shrouding of product add-ons. The highly influential “principles of persuasion” offered by Cialdini are considered, along with the role of sales scripts, emotion-triggering strategies and systems aimed at inducing “ego-depletion” to drive customers to spend more than they had planned. Finally, the chapter introduces economists to the notion of “demarketing,” i.e., strategies for dealing with time-wasting “customers” and excess demand for public services.

This chapter begins by noting the key ingredients in Akerlof and Shiller’s bestseller Animal Spirits but goes on to cover a far wider range of macroeconomics issues, including a detailed coverage of Minsky’s “financial instability hypothesis” that prefigures their work. After examining alternative theories of how speculative markets work and discussing herding behavior via both information and decision rule cascades, the chapter considers Keynesian view of animal spirits in relation to liquidity preference, leading to a discussion of Katana’s work on the impact of consumer confidence on discretionary spending. Next comes analysis of saving behavior in relation to innovative mortgage products and the impact of evolving bank lending rules on housing affordability. After considering Minsky’s work, material from earlier chapters is used to provide new perspectives on involuntary unemployment, inflation, exchange rate determination and the importance of non-price factors in the determination of international trade (with a discussion of the limited ways in which exchange rates shape trade). Finally, behavioral analysis of decision-making is applied to the making of macroeconomic policy.

This final chapter applies material from earlier chapters in the context of ecological economics and happiness economics. From the former it accepts that natural resource limitations (including capacities for storing waste products without harming the biosphere) require growth in per-capita incomes in advanced economies to be reined in, so the chapter focuses on how this can be done without making affluent consumers miserable. The type of change needed is shown via vignettes of materialistic and green lifestyles, bringing out the need to adopt more mindful ways of living and for society to make social standing a function of the contributions people make to social and environmental well-being rather than how wealthy or powerful a person is. Resistance to change is explored both in cognitive terms and in relation to the shortcomings of complex systems (e.g., transportation systems) in terms of missing links or prerequisites. However, since the book’s analysis is not based on fixed preference systems and it applies the idea of brain plasticity being an inherent consequence of thinking, the key thing is whether people will be able to change before environmental tipping points are reached.

The premise of this chapter is that it is useful to know why problems arise in everyday life before trying to understand how people set about trying to solve problems and thereby gain control and make their lives more predictable. We examine first how finite information processing and imaginative capacities limit how well existing problems can be analyzed, leading to further surprises for decision-makers. Next, we explore problems of obtaining knowledge about the behavior of others (that results in coordination failures) and of limited time to search and the problems posed by experience goods and credence goods. We then take a complex systems view of why some kinds of environments and products are prone to generate problems. This analysis emphasizes the significance of the connective structural architecture of systems, how linkages can cause problems to compound, the advantages of modular systems and the problems caused by absent prerequisites or corequisite elements for system functioning (in contrast to the presumption of substitution in orthodox economics). In light of this, there is a consideration of what it means to “get one’s priorities wrong” and the cognitive and systems challenges of poverty.

This chapter explores how people characterize and cope with the cognitive challenges they face when they perceive uncertainty. Economists normally model how people think about uncertainty in terms of probability distributions assigned to rival outcomes on the dimension in question, but people commonly speak with a focus on whether outcomes are “probable” or merely “possible.” The chapter therefore explores differences between subjective probability concepts and Shackle’s possibility-based “potential surprise” view of uncertainty and his theory of focus outcomes. We also examine probability-assigning heuristics and inductive and deductive philosophies for assigning how probable or possible events might be. We then consider rule-based method by which people deal with “fundamental uncertainty,” where probabilities cannot be assigned and a leap in the dark must be made. Finally, the chapter focuses on how people deal with dread that specific problematic events may occur, including decisions to bail out of commitments due to short-run loss of nerve, leading to losses of major long-term benefits. This discussion includes analysis of how terrorism works despite low odds of being a victim.