BBC Radio 4's Analysis: The Economy on the Couch, was broadcast on Thursday, 2 December, 2004 at 20:30 GMT.
What is the difference between economic theory and practice?
In the Ultimatum Game, you are given £10 and told to split it with someone else. If the other person rejects the way the money is split, both of you go home with nothing.
So how would you split it?
Economic theory predicts that even if you keep £9 and offer £1, the deal should be accepted. You are offering someone free money after all, so why would they turn it down?
But they do. In experiments, most people veto the deal and so you both lose the cash if they're offered less than £3 or £4.
The Ultimatum Game is one example of a new branch of economics, known as behavioural economics, which is said by some of its proponents to be a fundamental challenge to the way we think about human decision-making. For what it shows, they say, is that people do not do the things theory expects them to do, in this case because values like fairness or emotions like envy turn out to be worth more than free money.
In Analysis this week, Diane Coyle explores the new frontier of behavioural economics, learning what it has discovered about the rationality of choices we all make, from our apparent belief when thinking of pensions that we won't get old, to the way we shop or buy shares. She looks at the work of experimental economists whose laboratory subjects are ordinary people asked to make decisions, sometimes while their brains are scanned to see which bits light up when certain decisions are taken.
Behavioural economics sometimes claims to be economics with added psychological realism. But if that's right, if economics never was realistic in the past, why did the old models survive so long, what changes might these new insights bring about in economic policy making, and could revelations about our own irrationality invite a more paternalistic state if we prove unable to act on our own best interests?
Presenter: Diane Coyle
Producer: Michael Blastland
Editor: Nicola Meyrick