Behavioral Economics

- An overview

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 Table of Contents
Introduction 3

Motivations 4

Methods 5

Advantages of Experiments 6

Disadvantages of Experiments 7

Some common biases, heuristics and fallacies 8

References 20

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Introduction

What is behavioral economics?

● Studies effects of psychological, cognitive, emotional, cultural and social

factors on the decisions of individuals and institutions
● Primarily concerned with the bounds of rationality of economic agents
● Behavioral models typically integrate insights from psychology, neuroscience
and microeconomic theory

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 Motivations

The two main motivations:

1. People sometimes make choices that are difficult to explain with standard
economic theory
2. Standard economic theory can lead to seemingly unreasonable conclusions
about consumer welfare

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 Methods

● Assumes individuals have well-defined objectives

● Subjects theories to careful empirical testing
● Important difference is use of experiments using human subjects
● Behavioral economists tend to use experimental data to test their theories
rather than drawing data from the real world

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Advantages of Experiments

● Easier to determine whether people’s choices are consistent with standard

economic theory by ruling out alternative explanations
● Often easier to establish causality
● Researchers can double-check their assumptions and conclusions

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Disadvantages of Experiments

● Decisions made in the lab differ from decisions made in the real world
● Introduce influences on decision making that are hard to measure or control
● Most subjects are students, thus not representative of the general population
● Scale of any given experiment is limited by the available resources

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Some common biases, heuristics and
fallacies

Framing

● Choices can be presented in a way that highlights the positive or negative

aspects of the same decision
● Different types of framing approaches have been identified
 Anchoring
● Initial exposure to a number serves as a reference point and influences
subsequent judgments
● Usually occurs without our awareness (Tversky & Kahneman, 1974)
● Researched in many contexts

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Loss Aversion

“Losses loom larger than gains” (Kahneman & Tversky,

1979)

People are more willing to take risks (or behave

dishonestly; e.g. Schindler & Pfattheicher, 2016) to
avoid a loss than to make a gain

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Confirmation Bias

Occurs when people seek out or evaluate information in a way that fits with their
existing thinking and preconceptions.

Domain of science has not been immune to bias, which is often associated with
people processing hypotheses in ways that end up confirming them (Oswald &
Grosjean, 2004).

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Winner’s Curse

● Generally occurs in auctions

● Winner is the bidder with the most optimistic evaluation of the asset
● Winner tends to be "cursed" in one of the two ways:
1. Winning bid exceeds the value of the auctioned asset making the winner
worse off in absolute terms
2. Value of the asset less than bidder anticipation: bidder may garner a net
gain but will be worse off than anticipated
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 Sunk cost

● Occurs when individuals continue a behavior or endeavor as a result of

previously invested resources (time, money or effort) (Arkes & Blumer, 1985)
● If the costs outweigh the benefits, the extra costs incurred (inconvenience,
time or even money) are held in a different mental account than the one
associated with the ticket transaction (Thaler, 1999)

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 References

Behavioral economics resources

Center for advanced hindsight: Behavioral science | Behavioral economics

Winner's curse - Wikipedia

Anomalies: The Winner's Curse (Richard H. Thaler)

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