Ecological economics/eco-economics refers to both a transdisciplinary and interdisciplinary field of academic research that aims to address the interdependence and coevolution of human economies and natural ecosystems over time and space. It is distinguished from environmental economics, which is the mainstream economic analysis of the environment, by its treatment of the economy as a subsystem of the ecosystem and its emphasis upon preserving natural capital.
Heterodox economics refers to methodologies or schools of economic thought that are considered outside of “mainstream economics”, often represented by expositors as contrasting with or going beyond neoclassical economics. “Heterodox economics” is an umbrella term used to cover various approaches, schools, or traditions. These include socialist, Marxian, institutional, evolutionary, Georgist, Austrian, feminist, social, post-Keynesian (not to be confused with New Keynesian), and ecological economics among others.
Institutional economics focuses on understanding the role of the evolutionary process and the role of institutions in shaping economic behaviour. Its original focus lay in Thorstein Veblen’s instinct-oriented dichotomy between technology on the one side and the “ceremonial” sphere of society on the other. Its name and core elements trace back to a 1919 American Economic Review article by Walton H. Hamilton. Institutional economics emphasizes a broader study of institutions and views markets as a result of the complex interaction of these various institutions (e.g. individuals, firms, states, social norms). The earlier tradition continues today as a leading heterodox approach to economics. Institutional economics focuses on learning, bounded rationality, and evolution (rather than assume stable preferences, rationality and equilibrium). Tastes, along with expectations of the future, habits, and motivations, not only determine the nature of institutions but are limited and shaped by them. If people live and work in institutions on a regular basis, it shapes their world-views. Fundamentally, this traditional institutionalism (and its modern counterpart institutionalist political economy) emphasizes the legal foundations of an economy (see John R. Commons) and the evolutionary, habituated, and volitional processes by which institutions are erected and then changed (see John Dewey, Thorstein Veblen, and Daniel Bromley.)
The vacillations of institutions are necessarily a result of the very incentives created by such institutions, and are thus endogenous. Emphatically, traditional institutionalism is in many ways a response to the current economic orthodoxy; its reintroduction in the form of institutionalist political economy is thus an explicit challenge to neoclassical economics, since it is based on the fundamental premise that neoclassicists oppose: that economics cannot be separated from the political and social system within which it is embedded.
Behavioral economics, along with the related sub-field, behavioral finance, studies the effects of psychological, social, cognitive, and emotional factors on the economic decisions of individuals and institutions and the consequences for market prices, returns, and the resource allocation. Behavioral economics is primarily concerned with the bounds of rationality of economic agents. Behavioral models typically integrate insights from psychology, neuroscience and microeconomic theory; in so doing, these behavioral models cover a range of concepts, methods, and fields. Behavioral economics is sometimes discussed as an alternative to neoclassical economics.
In 1979, Kahneman and Tversky wrote Prospect Theory: An Analysis of Decision Under Risk, an important paper that used cognitive psychology to explain various divergences of economic decision making from neo-classical theory. Prospect theory has two stages, an editing stage and an evaluation stage.
In the editing stage, risky situations are simplified using various heuristics of choice. In the evaluation phase, risky alternatives are evaluated using various psychological principles that include the following:
(1) Reference dependence: When evaluating outcomes, the decision maker has in mind a “reference level”. Outcomes are then compared to the reference point and classified as “gains” if greater than the reference point and “losses” if less than the reference point.
(2) Loss aversion: Losses bite more than equivalent gains. In their 1979 paper in Econometrica, Kahneman and Tversky found the median coefficient of loss aversion to be about 2.25, i.e., losses bite about 2.25 times more than equivalent gains.
(3) Non-linear probability weighting: Evidence indicates that decision makers overweight small probabilities and underweight large probabilities – this gives rise to the inverse-S shaped “probability weighting function”.
(4) Diminishing sensitivity to gains and losses: As the size of the gains and losses relative to the reference point increase in absolute value, the marginal effect on the decision maker’s utility or satisfaction falls.