Figure 1 - Some of the most influential behavioral economists
Today, behavioral economics is still considered a relatively young field in economics. For this reason, it is a very attractive domain for prospective economists, psychologists, and researchers — or anyone who feels the itch to refine economic models by accounting for human psychology and irrationality.
Some principles and examples of behavioral economics
Because behavioral economics defies the idea that humans behave rationally when making decisions, it proposes a selection of generalizable situations or principles to illustrate this in practice. These principles are often referred to as cognitive biases and can be thought of as the themes or subtopics studied within behavioral economics. They are backed by experiments and research that demonstrate how human psychology intervenes when people actually make decisions in economic situations.
Anchoring
The anchoring and framing effects were conceptualized by Daniel Kahneman and Amos Tversky. In his book Thinking Fast and Slow (2011), Kahneman explains that anchoring is “the tendency to rely too much on an initial piece of random information—the anchor—which is then used to make subsequent decisions.” For example, say you are looking to buy a shirt. The first one you see costs £20, and the second one £10. The anchoring effect will make you think that the second shirt was “cheap” because you took the price of the first one as a reference, base rate or anchor — influencing your purchasing decision.
Framing
Framing instead happens when “we make choices based on whether they are presented as gains or losses” (Kahneman, 2011). That is, communicating information in one way or another will affect our decision-making. A typical example is when we are presented with two yogurt options in a supermarket, with one labeled as containing “20% fat” and the other one as being “80% fat free.” The second option is generally perceived to have less fat content. This, in turn, will affect the choice the customer makes despite both products being the same.
Loss aversion
The idea that most people have a strong preference for avoiding losses as opposed to acquiring gains is known as loss aversion. This concept was, again, jointly developed by Kahneman and Tversky as a crucial part of their prospect theory. Kahneman and Tversky explain that