Behavioral economics helps us understand how individuals make economic decisions and

why they do so. Behavioral economics relates in many things in my life, firstly through my
spending habits. When I am spending my hard-earned money from my summer work or
from my student loan I may think that I am making the right rational economic decisions,
this is not always the case though as I am actually influenced by many biases and heuristics.
I may be more inclined to buy something if it was on sale or was part of any limited-time
deal. I can end up making choices that aren’t in my best interest or beneficial to me due to
these biases and heuristics.
Secondly, behavioral economics also relates to my life through my savings habits. Although I
may have good intentions I can be swayed by present bias, this indicates that I priorities
short-term gains above long-term objectives. This can lead me to spend money on items I
don’t actually need rather than put towards something more useful in future.

The endowment effect is a behavioral economic anomaly which violates standard neoclassic
economic theory. This is when an individual values something more highly if they already
own it. This means that it violates principle of rationality, as principle of rationality assumes
that individuals should value something on its characteristics as opposed to ownership of it.
E.g. I may value my used golf clubs higher or similar to golf clubs I do not own. This can lead
to rational decisions being holding onto assets which aren’t worth as much as I think.

To accommodate this anomaly of endowment effect, prospect theory is used. This was
created in 1979 by Daniel Kahneman and Amos Tverksy. Prospect theory accounts for
impact of emotions and cognitive biases on decision making. Economists can use this to
create better understanding of decisions people make in economic market so they can
modify economic theory to accommodate for these. If these principles are better
understood by individuals then better financial decisions can be made which will improve
overall financial wellbeing.