# Behavioral Economics Behavioral Economics is a field that combines insights from [[Cognitive Psychology]] with economic theory to understand how people actually make decisions, rather than how rational models predict they should. Pioneered by [[Daniel Kahneman]] and [[Amos Tversky]] in the 1970s and expanded by [[Richard Thaler]], it demonstrates that humans systematically deviate from rational choice due to [[Cognitive biases]], [[Heuristics]], and emotional factors. Kahneman won the Nobel Prize in Economics in 2002 for this work. Classical economics assumed "homo economicus"—rational actors who maximize utility with perfect information. Behavioral economics replaced this with realistic models of human behavior, showing that we use mental shortcuts, are influenced by how choices are framed, feel losses more than gains, and often act against our own long-term interests. This has profound implications for public policy ("nudge" theory), marketing, finance, and personal decision-making. The field bridges [[Bounded Rationality]] (Herbert Simon) with practical applications. ## Classical vs Behavioral Economics | Aspect | Classical Economics | Behavioral Economics | |--------|--------------------|--------------------| | **Human model** | Rational optimizer | Bounded rationality | | **Information** | Perfect | Limited, costly | | **Preferences** | Stable, consistent | Context-dependent | | **Self-control** | Perfect | Limited willpower | | **Emotions** | Irrelevant | Central to decisions | | **Time** | Consistent discounting | Present bias | ## Key Concepts | Concept | Description | Example | |---------|-------------|---------| | **[[Prospect Theory]]** | Losses hurt more than gains feel good | Holding losing stocks | | **Loss aversion** | ~2× weight on losses vs gains | Risk-averse for gains, risk-seeking for losses | | **Framing effects** | Presentation affects choice | "90% survival" vs "10% mortality" | | **Mental accounting** | Money treated differently by source | Spending windfall vs salary | | **Present bias** | Overweight immediate rewards | Procrastination | | **Status quo bias** | Prefer current state | Not switching providers | | **Anchoring** | First number influences estimates | Salary negotiations | ## Dual-Process Theory ``` ┌─────────────────────────────────────────────────────────────┐ │ DECISION MAKING │ ├─────────────────────────────┬───────────────────────────────┤ │ SYSTEM 1 (Fast) │ SYSTEM 2 (Slow) │ ├─────────────────────────────┼───────────────────────────────┤ │ • Automatic │ • Effortful │ │ • Intuitive │ • Deliberate │ │ • Emotional │ • Logical │ │ • Parallel processing │ • Sequential │ │ • Uses heuristics │ • Uses rules │ │ • Prone to biases │ • Can override biases │ │ • Always on │ • Lazy, needs motivation │ └─────────────────────────────┴───────────────────────────────┘ Most decisions use System 1; System 2 activates for complex problems ``` ## Key Figures | Person | Contribution | |--------|--------------| | [[Daniel Kahneman]] | Prospect theory, System 1/2 (Nobel 2002) | | [[Amos Tversky]] | Heuristics and biases program | | [[Richard Thaler]] | Nudge theory, mental accounting (Nobel 2017) | | [[Herbert Simon]] | Bounded rationality (Nobel 1978) | | Cass Sunstein | Nudge, choice architecture | | Dan Ariely | Predictably irrational behavior | ## Applications | Domain | Application | |--------|-------------| | **Public policy** | Nudges, default options (organ donation) | | **Finance** | Behavioral finance, investor psychology | | **Marketing** | Pricing psychology, framing | | **Health** | Default enrollment, commitment devices | | **UX Design** | Choice architecture, defaults | | **Retirement** | Auto-enrollment, escalating savings | ## Nudge Theory | Nudge Type | Mechanism | Example | |------------|-----------|---------| | **Default options** | Opt-out vs opt-in | Retirement savings enrollment | | **Social proof** | "Most people do X" | Hotel towel reuse | | **Simplification** | Reduce friction | Pre-filled forms | | **Salience** | Make info visible | Calorie labels | | **Commitment devices** | Lock in future behavior | Gym contracts | ## References - Kahneman, D. (2011). *Thinking, Fast and Slow* - Thaler & Sunstein (2008). *Nudge* - https://en.wikipedia.org/wiki/Behavioral_economics ## Related - [[Cognitive Psychology]] - [[Decision Making]] - [[Cognitive biases]] - [[Heuristics]] - [[Prospect Theory]] - [[Bounded Rationality]] - [[Daniel Kahneman]] - [[Amos Tversky]] - [[Richard Thaler]]