The Nobel Prize in Economics this year will be divided between two men--Daniel Kahneman of Princeton University and Vernon Smith of George Mason University--who have been pushing the field toward empirical science and linking it to human behavior.
Kahneman, 68, is being honored for integrating insights from psychology into theories of economic behavior, especially in relation to decision-making in uncertain situations. Economists have increasingly come to acknowledge that humans do not make choices with perfect rationality. Kahneman, working with Amos Tversky, who died in 1996, formulated what he calls "prospect theory" to account for the way people really act. He has described how people develop heuristics, or short-cuts, in evaluating choices, and has identified particular quirks in reasoning that reflect human nature more than they do accurate perceptions of potential risk or gain. He has demonstrated, for example, that people are more adverse to the risk of losing something than they are attracted to the idea of gaining the same thing. One experiment found that students who had been randomly given coffee mugs wanted twice as much money to part with them as mugless students were willing to pay to acquire one.
"This was no surprise," says Princeton economist Michael Rothschild. "I [and others] predicted Kahneman in the departmental pool," he says. People have been impressed by his work for the past 30 years, says Rothschild, but "it took a long time" for researchers to figure out how to integrate it into economics.
Vernon Smith, 75, helped lay the foundation for the field of experimental economics. Although economists had long held certain mechanistic ideas about the market--how, for example, new taxes will shift the supply-and-demand curve--Rothschild says, "Smith initiated the notion that you could actually use experiments to check the predictions of economic theory, particularly the actions of markets." Smith's recent experiments, which he likes to think of as "wind tunnels" of economics, have ranged from testing competing models for energy deregulation to assigning airport slots. "No one is more deserving of this prize," says Terry L. Anderson, executive director of the Political Economy Research Center in Bozeman, Montana. "Vernon's research on natural resource and environmental issues is perhaps as important as his work on experimental economics."