Economic Psychology and Behavioral Economics Lecture Notes

A comprehensive set of vocabulary flashcards covering the economic, psychological, and behavioral principles discussed in the lecture notes, including heuristics, prospeact theory, labor psychology, and well-being models.

Economic expectations

Conjectures people make about future economic events based on past experiences, learning processes, and current knowledge or opinions about new circumstances.

Consumer Sentiment Index

A measure of consumers' subjective feelings regarding their individual financial situations and the overall economic conditions used to capture confidence and predict economic developments.

Opportunity costs

The costs incurred when choosing one alternative over another, implying giving up the benefits of the alternative not selected.

Production possibilities curve

A curve describing the maximum combinations of goods that can be produced given a specific level of resources used at full capacity; also known as the production transformation curve.

Profit maximisation principle

An economic principle aiming to achieve the maximum result possible with a given quantity of resources.

Cost minimisation principle

An economic principle aiming to achieve a specific result using the minimum amount of resources.

Axioms

Basic assumptions about individual preferences that form the core of the rationality assumption in economics.

Completeness

The assumption that actors are capable of ranking different alternatives into a consistent preference order.

Transitivity

The assumption of a consistent preference order where if an actor prefers A to B and B to C, they must also prefer A to C.

Reflexivity

The assumption that any bundle of alternatives is considered at least as good as itself.

Non-satiation

The assumption that actors always prefer to possess more of a good rather than less.

Continuity

The assumption that the loss of a specific quantity of one good can be compensated for by receiving a specific quantity of another good.

Convexity

The assumption that an actor with a small amount of one good and a large amount of another will only be indifferent to losing the scarce good if they receive a proportionally larger quantity of the abundant good.

Homo economicus

The theoretical paradigm of an actor who behaves perfectly rationally and consistently seeks to maximise their own utility.

Economic psychology

The field studying psychological mechanisms and processes underlying consumption and economic behaviors, including preferences and impacts on well-being.

Financial psychology

A branch of economic psychology studying experiences and behaviors of individuals dealing with money or highly liquid investments.

Time discounting

The preference for immediate utility over delayed utility in decisions where consequences occur at different points in time.

Fundamental law of effect

The learning theory principle that behavior is influenced by its consequences, explaining focus on current utility differences.

Law of relative effect

Also known as the Matching law, it states the selection ratio of behavioral alternatives is proportional to the subjective value of reinforcements and inversely proportional to delay time.

Melioration

The tendency to choose the alternative that improves one's position for the time being, which can counteract long-term total utility maximization.

Better-than-average effect

The psychological belief that one's positive traits are more developed and negative traits are less developed than those of others.

Peak and end rule

The rule suggesting experiences are judged not by total duration but by the most outstanding elements and those at the very end.

Hindsight bias

The tendency for people to claim they knew an outcome all along after learning it; also known as the Knew-it-all-along bias.

Heuristics

Rules of thumb allowing individuals to reach judgments or decisions quickly in complex situations.

Availability heuristic

Making judgments based on the ease with which specific information can be retrieved from memory.

Mood-as-information heuristic

A process where individuals use their current mood as a direct source of information to form a judgment.

Representativeness heuristic

Judgments based on the similarity between an outcome and a mental model or category.

Gambler’s fallacy

The mistaken belief that if an outcome has occurred frequently in a sequence, the alternative outcome becomes more likely next.

Hot hand fallacy

The mistaken belief that after a sequence of successes, another success is more likely to follow.

Conjunction fallacy

The error of believing that combined events are more likely than the single events that constitute them.

Anchoring and adjustment heuristic

Making judgments by starting from an initial value and making an inadequate adjustment from that value.

Affect heuristic

Making judgments of risk, probability, or quantity based on cues from positive and negative feelings.

Fast and frugal heuristics

Decision-making aids designed to solve complex problems quickly using a minimal amount of information.

Recognition heuristic

A strategy where if only one of two objects is recognized, it is judged as more important or higher in value.

Less-is-more effect

A phenomenon where having less knowledge enables the use of the recognition heuristic, leading to better decisions.

Take-the-best heuristic

A strategy where a decision is based solely on the one characteristic that seems most relevant.

Elimination heuristic

A method where decisions are made by sequentially eliminating alternatives that do not meet certain criteria.

Framing effects

Changes in decision-makers' preferences based on how a problem is presented, even if objective outcomes are identical.

Asian disease problem

A classic decision problem involving $600$ people used to demonstrate that framing in terms of lives saved leads to risk-aversion, while lives lost leads to risk-seeking.

Prospect theory

A descriptive model of decision-making under uncertainty focused on how subjective utility is maximized based on perceptions of probabilities and consequences.

Editing phase

The first stage of prospect theory where options are restructured and a reference point is chosen to define results as gains or losses.

Evaluation phase

The second stage of prospect theory where options are assessed using the value and weighting functions.

Value function

Describes an S-shaped relationship: concave for gains (risk-aversion), convex for losses (risk-seeking), and steeper for losses (loss aversion).

Weighting function

Describes how objective probabilities relate to subjective weights, where low probabilities are overweighted and medium-to-high probabilities are underweighted.

Endowment effect

The tendency for a good to become more valuable immediately after possession because giving it up is perceived as a loss.

Sunk cost effect

The tendency to continue an endeavor once resources (money, time, effort) are invested, even when those resources are irretrievable.

Mental accounting

A cognitive process where individuals record costs and benefits in event-specific ways and budget sums for specific categories.

Hedonic framing

Strategies to maximize satisfaction; gains should be segregated (separated) and losses should be integrated (combined).

Bounded rationality

The concept that the human ability to behave perfectly rationally is limited by cognitive constraints.

Satisficing principle

A decision-making process within bounded rationality where the first satisfactory alternative meeting minimum criteria is chosen.

Implicit favourite model

A model where decision-makers choose an option early and spend effort searching for confirmation to justify it.

Groupthink

A phenomenon where cohesive groups make suboptimal decisions due to isolation, pressure to conform, and charismatic leadership.

Garbage can model

An organizational model where problems and solutions float together, and decisions occur through coincidental combination.

Muddling through

An incremental, step-by-step decision process often found in politics, taking small steps until negative consequences force a change.

Logic of success

A strategy for complex situations involving concrete goals, wide-ranging plans, and monitoring effects.

RAWFS model

A framework for uncertainty using five tactics: Reduction, Assumption-based reasoning, Weighing pros/cons, Forestalling, and Suppression.

Nudges

Attempts to structure the decision architecture to encourage rational behavior without mandating choices or using financial sanctions.

MINDSPACE

A framework for nudging summarizing influences: Messenger, Incentives, Norms, Defaults, Salience, Priming, Affect, Commitments, and Ego.

EAST

A simplified nudging framework for encouraging behavior by making it Easy, Attractive, Social, and Timely.

Theory of social representations

The theory that individual opinions are shared within a community as a complex result of experiences and emotionally loaded judgments.

Common sense

Within social representation, the state when an unfamiliar phenomenon becomes familiar through discourse and collective coping.

Core elements

The central parts that define the meaning and organize a social representation.

Peripheral elements

Elements that make the core of a social representation concrete, adapt to context, and protect the stable core.

Anchoring

The process of linking a new social representation to existing, familiar categories.

Objectification

The process of making an abstract concept vivid through images, symbols, or metaphors.

Belief in a just world

The psychological need to assume outcomes are not random and that people get what they deserve.

Social categorisation theory

The theory that information about people and objects is stored in mental schemata formed through categorization.

Assimilation effects

When similarities within a category are perceived as more pronounced than they actually are.

Contrast effects

When differences between categories are perceived as more pronounced than they actually are.

Social identity theory

The theory that people derive part of their self-concept from membership in social groups.

Cognitive-developmental theory

A theory based on Piaget stating intelligence develops through adaptation processes of assimilation and accommodation.

Assimilation (Piaget)

The adaptation of the environment to the individual during cognitive development.

Accommodation (Piaget)

The adaptation of the individual to the environment during cognitive development.

Sensorimotor intelligence

A developmental stage from approximately $0-2$ years involving linking ends and means through active experimenting.

Preoperational thought

A developmental stage from approximately $2-7$ years involving internalisation of symbols and mental representations.

Concrete operational thought

A developmental stage from approximately $7-11$ years involving coordinated transformations and the loss of egocentrism.

Formal operations

A developmental stage from approximately $11$ years to adulthood involving mental operations independent of concrete objects.

Financial literacy

The specific ability to understand and use financial concepts.

Financial capability

A broad concept encompassing knowledge, skills, confidence, and attitudes regarding financial matters.

Windfall gains

Unexpected financial gains that are typically spent more easily or invested more riskily than earned money.

Money illusion

When the perceived economic value of money is influenced by nominal units rather than its real value.

Euro illusion

Difficulties in adapting to new scaling and nominal prices following the introduction of the Euro.

Selective outcome correction process

A process where errors in price comparisons are detected and corrected if they contradict initial expectations.

Price–quality heuristic

The subjective belief that a higher price necessarily indicates higher quality.

Psychological prices

Prices designed to seem significantly below a round number, such as $19.99$; also includes $9$-ending prices.

Image effects

Influences on the perception of the good itself or the price-good relationship, such as making it seem like a sale.

Level effects

Influences on the perception of the price amount itself, such as through rounding down.

Extensive decisions

Decisions involving complex information processing by the consumer.

Syncratic decisions

Household decisions made jointly by two or more persons, likely when financial commitment is high.

Autonomous decisions

Household decisions made by one partner while taking the other partner's preferences into account.

Probability conflicts

Differences of opinion occurring when people agree on the goal but disagree on the way to reach it.

Value conflicts

Differences of opinion occurring when people disagree about the goal to be pursued.

Distribution conflicts

Differences of opinion occurring when people disagree about how resources should be allocated.

Interaction principles

Framework for relationships based on power and harmony: Love, Credit, Equity, and Egoism.

Influence debts

Incurred when one partner has more influence in a specific purchase decision.

Utility debts

Incurred when one partner receives more benefit from a specific purchase.

Relative resources theory

Suggests household influence is determined by social norms and partners' relative contributions of resources.

Hierarchy-of-effects models

Models describing advertising effects as a think-feel-do sequence; Includes the AIDA model (Attention, Interest, Desire, Action).

Elaboration likelihood model (ELM)

Assumes persuasion happens via a central route (high involvement) or a peripheral route (low involvement/heuristic cues).

Reflective-impulsive model

Posits behavior is a mix of impulsive and reflective processes, with the former growing with habit.