4.1.2.3 Aspects of behavioural economic theory

Behavioural economics

a field of study that explores how psychological, emotional, and social factors influence economic decision-making

homo economicus

• Behavioural economics challenges this traditional assumption

• The concept that individual are always rational and self-interested

systematic bias

• Heuristics lead to this

• a predictable and repeated mistake caused by how people think, while an error is one-time, random mistake

present bias

a phenomenon where individuals may over value immediate rewards and underestimate future benefits

cognitive bias

these are patterns of thinking that lead people to make irrational or less-than-optional decisions

“the difference between an error and a bias is that a bias has a pattern and an error is random”

What did Daniel Kahneman say?

loss aversion

• consumers feel pain of losing something more strongly than the pleasures of gaining the same thing

• One common bias is

consumers may avoid investing in stock, even with high potential returns, because they fear the possibility of losing money more

application for loss aversion

may not always make choices that maximise utility

What is a result of cognitive bias?

why real life behaviour often differs from traditional economic models

Understanding cognitive bias helps explain:

heuristics, anchoring, availability, social norms

What are examples of cognitive bias?

heuristics

• Mental shortcuts made by consumers to reduce decision-making effort when time, energy, and/or information is limited

• Stops consumers from maximising their utility

Helps people make quick choices based on simple rules or past experience

What do heuristics help with?

someone may keep renewing the same mobile phone contract each year without checking for cheaper or better deals

example of heuristics

anchoring

when consumers rely too heavily on the first piece of info. they see when making a decision(even if its not relevant), changing spending behaviour

Helps explain why price presentation can strongly influence consumer choices

What does anchoring help with?

if a sofa is labelled as “£1k, now £600” many people see it as a good deal - not neccessarily because £600 is cheaper but because £1k makes it seem like a big saving

Example of anchoring

availability

when people make decisions based on what is easy to remember, not what is most accurate or likely

• Leads to decision that don’t reflect real risks or benefits, esp. in areas like health spending, saving or borrowing

why some consumers avoid financial products like insurance or investment - they remember dramatic stories more than data.

What does availability bias help with?

if someone hears a new story of someone losing all their money in a stock market crash, they may avoid investing, even if long-term returns are usually higher than saving

example of availability bias

social norms

informal rules about how people think they should behave based on what others are doing

• Demonstrates how consumer behaviour is influenced by society and culture, not just personal benefit or rational calculation

to social pressure or shared values, which can be more powerful in influencing behaviour than a good’s price or quality

Social norms help explain how demand changes due

if many people in a community install solar panels, others may follow, as it’s seen as the ‘normal’ or responsible thing to do

example of social norms