An Brief Introduction To Behavioral Economics

Currently (November 2017), about ½ of my posts are related to Behavioral Economics. From theories related to marketing & branding to theories about overconfidence and performance level. But what is behavioral economics? This is the dedicated page that I made for behavioral economics. Let start with the definition shall we?

Just like other fields, there are many definitions of behavioral economics. But here is my simple definition of behavioral economics. Behavioral Economics is the study of human decision-making process of individuals and organizations with the help of both psychology and economics.

What is the difference with the economics that you studied in high school or universities? When you studying classical economics, you make assumptions. Well, the theories are based on a singular assumption. That we/people are all rational agents (minimize cost and maximize profit). Economics theories assume that we make decisions by maximizing and optimizing that leads to utility (satisfaction) maximization.

But after all, research has shown that we are not maximizers, we are not optimizers. We are Humans. We are heavily biased, easy to be manipulated, and sometimes we even confused about our own preferences, choices, etc. So knowing that most of us are irrational, those classical economics concepts are irrelevant. That’s the void that behavioral economics’ concepts will try to fill.

For about 40 years, behavioral economists have been studying our irrationality. Some of them become really popular now, such as Daniel Kahneman (author of Thinking Fast and Slow), Richard Thaler (author of nudge and misbehaving), Dan Ariely (author of Predictably Irrational), and many others. To get the idea of behavioral economics, below are some of the most popular behavioral economics concepts:

The endowment effect = The tendency for people to overvalue the products that they own that results to the pain to sell the products.

Sunk cost fallacy = When we continuing an activity based on the amount of resources we already invested. The more investment, the harder for us to abandon the activity. For example, because I already bought this $200 concert ticket, I forced myself driving my car through a very dangerous snowstorm.

House Money Effect = Initial win/profit, could make us take more risks. At the other side, initial lost could make us more risk-averse (take fewer risks).

Framing effect = The same choice will be perceived differently, depending on how it’s presented. For example, 80% fat-free yogurt or 20% fat yogurt?

So those are only 4 theories from thousands of theories that are available out there. In my opinion, behavioral economics is too good, too functional, and too useful, that it’s not fitted to be only used by myself, researchers, and academia. Behavioral economics is made for all of us (individuals & organizations)

Because with behavioral economics, individuals could know their common biases, fallacies, and errors so that they could avoid it. With behavioral economics, companies could try better understand their customers. With behavioral economics institutes and governments could try making a more effective law and regulation.

To end this brief introduction, I would like to give you some of my personal favorites videos and websites about behavioral economics :

Are we in control of our decisions? | Dan Ariely = https://www.youtube.com/watch?v=9X68dm92HVI

Predictably Irrational – basic human motivations: Dan Ariely at TEDxMidwest = https://www.youtube.com/watch?v=wfcro5iM5vw

https://www.behavioraleconomics.com/

https://behavioralviews.wordpress.com/category/economics-business/

REFERENCES AND SUPPORTING ARTICLES

Kahneman, D., Knetsch, J. L., & Thaler, R. H. (1991, 02). Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias. Journal of Economic Perspectives, 5(1), 193-206. doi:10.1257/jep.5.1.193

Staff, I. (2012, December 14). House Money Effect. Retrieved from http://www.investopedia.com/terms/h/house-money-effect.asp

Staff, I. (2012, December 14). House Money Effect. Retrieved from http://www.investopedia.com/terms/h/house-money-effect.asp

Thaler, R. H., & Johnson, E. J. (1990, 06). Gambling with the House Money and Trying to Break Even: The Effects of Prior Outcomes on Risky Choice. Management Science, 36(6), 643-660. doi:10.1287/mnsc.36.6.643

Thaler, R. H. (2016). Misbehaving: The making of behavioural economics. Penguin Books.

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