Behavioral Economics: Decision-Making Biases and Heuristics

Rational choice theory

The theory assumes that human actors have stable preferences and engage in maximizing behavior.

Delete frame

A customization process where customers start with a fully loaded model and must deselect or downgrade options.

Price anchor

A higher initial price anchor can make the final configured price seem more attractive than if the anchor was lower.

Loss aversion

We dislike losses more than we like an equivalent gain.

Bounded rationality

The idea that decision making is limited by available information, cognitive limitations, and time constraints.

Ecologically rational

They make the best possible use of limited information by applying simple algorithms suited to their environment.

Mental accounting

The theory that people treat money differently depending on its origin and intended use, rather than thinking of it in terms of a bottom line.

Fungibility

The economic principle that all money is interchangeable and has no labels, which mental accounting violates.

Transaction utility

In mental accounting, the pleasure derived from the quality of the deal itself, separate from the object's value.

Mental accounting bias

Investors who view recent gains as disposable house money to be used in high risk investments are demonstrating a bias related to mental accounting.

Pain of paying

A psychological phenomenon, related to loss aversion, that helps in consumer self regulation to keep spending in check.

Choice overload

A phenomenon where having too many choices available leads to negative outcomes like decision fatigue, unhappiness, or avoiding a decision altogether.

Counteracting choice overload

By simplifying choice attributes or reducing the number of available options.

Ostrich effect

The phenomenon where investors are less likely to check their portfolio online when the market is down.

Information avoidance

A situation where people choose not to obtain knowledge that is freely available.

Zero price effect

The tendency for consumers to perceive a product advertised as free as intrinsically and disproportionately more valuable.

Decoy effect

Occurs when people's preference for one option over another changes as a result of adding a third, similar but less attractive option.

Status quo bias

An emotional preference for the current state of affairs, where inertia leads people to stick with an option even if an alternative might be better.

Availability heuristic

Involves making judgments based on how easily specific examples come to mind.

Anchoring heuristic

Refers to the influence of a non-conscious numeric reference point on subsequent value perceptions.

Traditional game theory vs. behavioral game theory

Traditional game theory uses rational choice to predict decisions while behavioral game theory uses empirical models to explain how social preferences influence decisions.

Norm of reciprocity

The social norm of responding to a positive action with another positive action.

Herd behavior

The tendency for individuals to follow the actions of a larger group often ignoring their own information or judgment.

Hyperbolic discounting

The temporal bias that incentivizes immediate gratification over larger, delayed rewards.

Planning fallacy

The tendency for people to underestimate the time it will take to complete a future task.

Sunk cost fallacy

The tendency to continue an endeavor once an investment in money, effort, or time has been made, even if it's no longer the rational choice.