Behavioral economics studies how psychology affects economic decision-making. It examines how cognitive biases, emotions, and social factors influence choices, departing from the traditional assumption of perfectly rational actors.
Key Characteristics / Core Concepts
- Cognitive biases: Systematic errors in thinking that affect decisions (e.g., confirmation bias, anchoring bias).
- Heuristics: Mental shortcuts used to simplify decision-making, often leading to suboptimal outcomes.
- Framing effects: How the presentation of information influences choices, even if the underlying options remain the same.
- Loss aversion: The tendency to feel the pain of a loss more strongly than the pleasure of an equivalent gain.
- Prospect theory: A model that describes how individuals make decisions under conditions of risk and uncertainty.
How It Works / Its Function
Behavioral economics integrates insights from psychology and economics to build more realistic models of human behavior. It challenges the traditional assumption of rational choice by showing how psychological factors systematically distort choices.
These models then help explain seemingly irrational behaviors in economic contexts, such as overspending, impulsive purchases, and reluctance to save for retirement.
Examples
- The endowment effect: People place a higher value on things they own than on identical things they don’t own.
- The framing effect: People are more likely to choose a surgery with a 90% survival rate than one with a 10% mortality rate, even though they’re the same.
- Nudging: Subtle changes in the environment can influence choices, such as placing healthier food options at eye level in a cafeteria.
Why is it Important? / Significance
Behavioral economics has significant implications for various fields. It improves our understanding of consumer behavior, financial markets, public policy, and more.
By understanding how people deviate from rationality, we can design better policies, products, and services that align with actual human behavior and lead to better outcomes.
Related Concepts
- Cognitive Psychology
- Game Theory
- Neuroeconomics