Overview
Traditional economics assumes we are “Homo economicus”—perfectly rational calculators. Behavioral economics says we are Homer Simpson—impulsive, emotional, and prone to mistakes.
Core Idea
Bounded Rationality: Our rationality is limited by our cognitive capacity, the information we have, and the time available. We don’t optimize; we satisfice (aim for “good enough”).
Formal Definition (if applicable)
Prospect Theory: People value gains and losses differently. The pain of losing $100 is greater than the joy of finding $100 (Loss Aversion).
Intuition
Why do you buy a gym membership but never go? Why do you save more if the plan is “opt-out” rather than “opt-in”? Because we are lazy, optimistic, and bad at predicting our future selves.
Examples
- Nudge: Putting fruit at eye level in the cafeteria to encourage healthy eating.
- Sunk Cost Fallacy: Finishing a bad movie just because you paid for the ticket.
- Anchoring: Buying a $50 shirt because it was marked down from $100 (even if it’s only worth $50).
Common Misconceptions
- “It proves we are stupid.” (No, it proves we are human. Our biases often serve as useful shortcuts or heuristics.)
- “It replaces standard economics.” (It complements it by adding psychological realism.)
Related Concepts
- Heuristics: Mental shortcuts used to make quick decisions.
- Hyperbolic Discounting: Preferring $10 today over $15 next week (impatience).
- Choice Architecture: Designing the environment to influence decisions.
Applications
- Policy: Designing 401(k) plans to increase savings rates.
- Marketing: Pricing strategies (e.g., “Buy one, get one free”).
- Finance: Understanding market bubbles and crashes.
Criticism / Limitations
Some findings have failed to replicate (Replication Crisis in psychology). Also, “nudging” can be seen as manipulative or paternalistic.
Further Reading
- Kahneman, Thinking, Fast and Slow
- Thaler & Sunstein, Nudge