Intro

Sure, here are four paragraphs all about behavioural economics:

1. Behavioural economics is a field of study that combines insights from psychology and economics to
understand how people make decisions. Traditional economics assumes that people are rational and
make decisions based on a careful analysis of all available information, but behavioural economics
recognizes that people often make decisions based on emotions, biases, and heuristics. By studying
these non-rational factors, behavioural economists can develop better theories of how markets work
and how policies can be designed to promote desirable outcomes.

2. One of the key insights of behavioural economics is that people often suffer from cognitive biases that
lead them to make poor decisions. For example, people may overvalue immediate rewards and
undervalue long-term benefits, which can lead to unhealthy behaviours like smoking or overeating. They
may also be influenced by social norms, such as the desire to conform to the behaviour of others, even if
that behaviour is not in their best interest. These biases can be powerful drivers of human behaviour,
and understanding them is essential for designing effective policies.

3. Another important concept in behavioural economics is loss aversion, which refers to the fact that
people often feel the pain of losses more acutely than the pleasure of gains. This means that people may
be willing to take risks to avoid losses, even if the potential gains are small. For example, people may be
more likely to buy insurance to protect against a rare but catastrophic event, even if the cost of the
insurance is high relative to the expected payout. Understanding loss aversion can help policymakers
design policies that are more effective at managing risk and promoting desirable outcomes.

4. Finally, behavioural economics has important implications for business strategy and marketing. By
understanding how people make decisions, firms can design products and services that are more
appealing to consumers. For example, they can use the framing effect to present information in a way
that emphasizes the benefits of a product or service, or they can use social proof to show that others
have already made the same decision. By incorporating insights from behavioural economics into their
strategies, firms can gain a competitive advantage and better serve the needs of their customers.

Written by Chatsonic

7.1. What is behavioral economics?

7.2. Themes and methods of behavioral economics

Themes

Behavioral economics studies how people make decisions in different situations, especially when their
decisions are influenced by psychological, social, and emotional factors.

Some of the key themes of behavioral economics are::

1. Bounded Rationality: One of the key concepts in behavioral economics is that people's decision-
making abilities are constrained by their cognitive limitations, lack of information, and time constraints.
This means that people tend to make decisions based on the most relevant information available at the
time, which may not always be complete or accurate. For example, when choosing a health insurance
plan, people often focus only on the monthly premium, ignoring other important factors like
deductibles, co-pays, and network coverage. This is because they have limited cognitive resources, and it
becomes difficult to process all of the information.

2. Choice Architecture: This concept refers to the way in which choices are presented to people.
Behavioral economists believe that the way choices are framed can have a significant impact on
decision-making. For example, when choosing a flight, people often choose the direct route instead of
flying via a stopover. However, if the alternative is framed as a layover instead of a stopover, people are
more likely to choose the flight with the layover. This is because stopover is seen as a negative
experience, while a layover is seen as taking a break and relaxing.

3. Social and Cultural Influences: People's behavior is often influenced by social norms, culture, and the
people around them. For example, in a study conducted in the 1990s, a hotel placed a sign in their guest
rooms asking guests to reuse their towels. The sign had no effect on the guests' behavior. However,
when the sign included the message, "75% of other guests in this room reused their towels," the rate of
towel reuse increased significantly. This is because social norms and the behavior of others can influence
our own behavior.

4. Loss Aversion: People tend to feel the pain of losses more acutely than the pleasure of gains. This is a
key principle in behavioral economics, known as loss aversion. For example, if given the chance to either
win $100 or lose $100, people are more likely to choose the certain gain of $100, even though the
chance of losing $100 is equal to winning $100.

5. Time Inconsistency: This concept refers to the phenomenon that people often value immediate
rewards over long-term rewards. For example, when given the choice between receiving $100 today or
$110 in a week, most people would choose to receive $100 today, even though waiting a week would
result in a higher payout. This is because people tend to prioritize short-term pleasure over long-term
rewards.

6. Mental Accounting: This concept refers to the way in which people categorize their money into
different accounts, based on different sources or uses. For example, people may keep a separate savings
account for a vacation they want to take, or for a down payment on a new car. This mental accounting
can impact how people make decisions on spending and saving.

7. Behavioral Finance: This concept applies the principles of behavioral economics to the field of finance.
Behavioral finance helps in understanding how investors make financial decisions. People are not always
rational and capable of making perfect investment decisions; instead, their emotions and psychological
biases can impact their investment choices. For example, people may panic and sell their investments
during a market downturn, even though it may not be the best financial decision in the long run.

Methods

1. Default options: This method leverages the power of inertia to encourage people to make better
decisions. By setting a default option that is in the individual's best interest, such as automatically
enrolling employees in a retirement savings plan, people are more likely to stick with that option rather
than actively choosing a different one.

2. Incentives: This method uses rewards or punishments to motivate people to make better decisions.
For example, offering a financial incentive for reaching a health goal can encourage individuals to adopt
healthier behaviors.

3. Choice architecture: This method involves designing the environment in which decisions are made to
encourage better choices. For example, placing healthy food options at eye level in a cafeteria can
encourage individuals to choose those options over less healthy alternatives.

4. Social norms: This method leverages the power of social influence to encourage better decisions. By
highlighting the behavior of others who are making positive choices, such as displaying a sign that shows
how many people have recycled in a particular area, individuals are more likely to follow suit.
5. Information provision: This method involves providing individuals with information that can help
them make better decisions. For example, providing consumers with information about the nutritional
content of food products can help them make healthier choices.

6. Framing: This method involves presenting information in a way that influences how individuals
perceive it. For example, framing a product as "90% fat-free" rather than "10% fat" can make it more
appealing to consumers.

7. Feedback: This method provides individuals with feedback on their behavior to encourage better
decision-making. For example, providing individuals with feedback on their energy usage can encourage
them to adopt more energy-efficient behaviors.

Overall, these methods of behavioral economics can be used to encourage individuals to make better
decisions by leveraging the cognitive biases and social influences that shape their decision-making
processes. By understanding these factors and designing interventions that take them into account,
policymakers and organizations can nudge individuals towards better choices without restricting their
freedom of choice.

7.3. Anticipation and information avoidance

Information avoidance

Information avoidance in behavioral economics (Golman et al., 2017) refers to situations in which
people choose not to obtain knowledge that is freely available. Active information avoidance includes
physical avoidance, inattention, the biased interpretation of information (see also confirmation bias) and
even some forms of forgetting. In behavioral finance, for example, research has shown that investors are
less likely to check their portfolio online when the stock market is down than when it is up, which has
been termed the ostrich effect (Karlsson et al., 2009). More serious cases of avoidance happen when
people fail to return to clinics to get medical test results, for instance (Sullivan et al., 2004).

While information avoidance is sometimes strategic, it can have immediate hedonic benefits for people
if it prevents the negative (usually psychological) consequences of knowing the information. It usually
carries negative utility in the long term, because it deprives people of potentially useful information for
decision making and feedback for future behavior. Furthermore, information avoidance can contribute
to a polarization of political opinions and media bias.

References
Golman, R., Hagmann, D., & Loewenstein, G. (2017). Information avoidance. Journal of Economic
Literature, 55(1), 96-135.

Karlsson, N., Loewenstein, G., & Seppi, D. (2009). The ostrich effect: Selective attention to information.
Journal of Risk and Uncertainty, 38, 95–115.

Sullivan, P. S., Lansky, A., & Drake, A. (2004). Failure to return for HIV test results among persons at high
risk for HIV infection: Results from a multistate interview project. JAIDS Journal of Acquired Immune
Deficiency Syndromes, 35(5), 511–518.

7.4. Making choices under risk: prospect theory

Prospect theory is a psychological theory of decision-making under conditions of risk, which was
developed by psychologists Daniel Kahneman and Amos Tversky and originally published in 1979 in
Econometrica³. It describes how individuals make decisions between alternatives where risk is involved
and the probability of different outcomes is unknown¹. The model has been imported into a number of
fields and has been used to analyze various aspects of political decision-making, especially in
international relations³.

Prospect theory encompasses two distinct phases: (1) an editing phase and (2) an evaluation phase. The
editing phase refers to the way in which individuals characterize options for choice. Most frequently,
these are referred to as framing effects. Framing effects demonstrate the way in which the substance of
a person’s choice can be affected by the order, method, or wording in which it is presented³.

The evaluation phase refers to how individuals evaluate the options that have been edited. Prospect
theory states that decision-making depends on choosing among options that may themselves rest on
biased judgments. Thus, it built on earlier work conducted by Kahneman and Tversky on judgmental
heuristics and the biases that can accompany assessments of frequency and probability³.

There is a certainty effect exhibited in the prospect theory, where people seek certain outcomes,
underweighting only probable outcomes¹. The theory holds that people make decisions based on
perceived losses or gains⁵.

Would you like more information on this topic?

Source: Conversation with Bing, 6/1/2023

(1) Prospect theory | psychology | Britannica. https://www.britannica.com/topic/prospect-theory.

(2) Prospect Theory: What It Is and How It Works, With Examples - Investopedia.
https://www.investopedia.com/terms/p/prospecttheory.asp.

(3) Prospect Theory - Overview, Phases, and Features.

https://corporatefinanceinstitute.com/resources/capital-markets/prospect-theory/.

(4) Replicating patterns of prospect theory for decision under risk - Nature.
https://www.nature.com/articles/s41562-020-0886-x.

(5) ProspectTheory - University of Michigan Press. https://www.press.umich.edu/pdf/0472108670-

02.pdf.

(6) Prospect Theory: An Analysis of Decision Under Risk - SSRN.

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1505880.

Prospect theory is a theory of behavioral economics and behavioral finance that was developed by
Daniel Kahneman and Amos Tversky in 1979¹. The theory was cited in the decision to award Kahneman
the 2002 Nobel Memorial Prize in Economics¹.

Prospect theory belongs to the behavioral economic subgroup, describing how individuals make a choice
between probabilistic alternatives where risk is involved and the probability of different outcomes is
unknown². It describes how individuals make decisions between alternatives where risk is involved and
the probability of different outcomes is unknown. There is a certainty effect exhibited in the prospect
theory, where people seek certain outcomes, underweighting only probable outcomes².

The prospect theory assumes that losses and gains are valued differently, and thus individuals make
decisions based on perceived gains instead of perceived losses. Also known as the "loss-aversion"
theory, the general concept is that if two choices are put before an individual, both equal, with one
presented in terms of potential gains and the other in terms of possible losses, the former option will be
chosen².

Would you like more information on this topic?

Source: Conversation with Bing, 6/1/2023

(1) Prospect theory - Wikipedia. https://en.wikipedia.org/wiki/Prospect_theory.

(2) Prospect Theory: What It Is and How It Works, With Examples - Investopedia.
https://www.investopedia.com/terms/p/prospecttheory.asp.

7.5. Social preferences

Social preferences (e.g. Fehr & Fischbacher, 2002) are one type of preference investigated in behavioral
economics and relate to the concepts of reciprocity, altruism, inequity aversion, and fairness.

We will review evidence questioning the self-interest axiom

of the standard economic model

• We ask, to what extent do people exhibit social

preferences?

Social preferences are a concern, positive or negative, for the well being of others, and a desire to
uphold ethical norms. Social preferences include generosity toward others, a preference for “fair”
outcomes, and character virtues such as honesty. To the extent that humans exhibit social preferences,
this undermines the self-interest axiom of the standard economic mode

References

Fehr, E., & Fischbacher, U. (2002). Why social preferences matter: The impact of non-selfish motives on
competition, cooperation and incentives. The Economic Journal, 112(478), C1-C33.

**.

Social preferences in behavioral economics refer to the ways in which individuals' social values, norms,
and relationships influence their economic decision-making. This field of study is concerned with
understanding how people's preferences for fairness, reciprocity, and altruism affect their choices in
economic situations.
For example, research has shown that many people are willing to sacrifice some of their own financial
gain in order to ensure that others are treated fairly. This preference for equity can be seen in situations
such as salary negotiations, where individuals may be willing to accept a lower salary if they believe it is
fair in relation to others in their position.

Similarly, social preferences can also influence decisions related to charitable giving, investment choices,
and even consumer behavior. For instance, research has found that consumers may be more likely to
purchase products from companies that are seen as socially responsible or ethical.

Overall, the study of social preferences in behavioral economics provides important insights into the
complex ways in which social and economic factors interact to shape human decision-making.

7.5.1 distributional social preferences

Distributional social preferences refer to how individuals’ economic decision-making is influenced by

their preferences for the distribution of resources or outcomes across different members of society. In
other words, people’s social preferences can affect how they view inequality and how they make
choices that impact the distribution of resources. This concept is important in behavioral economics
because it helps to explain why people may not always act in their own self-interest and how social
values and norms can impact economic decision-making.

One example of distributional social preferences is the preference for fairness. People may be more
likely to choose an outcome that is perceived as fair, even if it means they receive less than they would
otherwise. This can be seen in situations such as salary negotiations or in the distribution of resources in
a group setting. People may also be more likely to opt for outcomes that benefit others, such as charity
donations, even if it means they receive no direct benefit themselves.

Another example of distributional social preferences is the preference for reciprocity. People may be
more likely to act in a way that benefits others if they expect a reciprocal action in return. This can be
seen in situations such as gift-giving or in business relationships where trust and reciprocity are
important factors. People may also be more likely to punish those who violate social norms or who do
not act in a way that is perceived as fair or reciprocal.

Distributional social preferences can also vary across different cultures and societies. For example, some
cultures may place a higher value on cooperation and sharing resources, while others may place more
emphasis on individual achievement and competition. As a result, people from different cultures may
have different distributional social preferences and may make different economic choices based on
these preferences.

Overall, distributional social preferences provide important insights into the complex relationship
between social and economic factors. By understanding how people’s preferences for the distribution of
resources and outcomes can impact economic decision-making, researchers can develop more accurate
models of human behavior and make more informed policy decisions.

Written by Chatsonic

7.5.2 intensions based social preferences

Intention-based social preferences refer to the idea that individuals' economic decision-making is
influenced not only by the outcomes of their actions, but also by the intentions behind those actions.
This means that people may be more likely to cooperate and share resources with others who they
believe have good intentions, even if the outcomes are not necessarily favorable. Conversely, people
may be less likely to cooperate with those they perceive as having bad intentions, even if the outcomes
are beneficial.

One example of intention-based social preferences is the ultimatum game, where one player proposes a
division of a sum of money and the other player can either accept or reject the proposal. If the proposal
is rejected, neither player receives any money. In this game, proposers who offer more than the
minimum amount are viewed as having good intentions, and responders are more likely to accept these
offers than those who offer less than the minimum amount. This suggests that people are willing to
forego potential gains in order to punish those they perceive as having bad intentions.

Intention-based social preferences can also be influenced by cultural factors. For example, research has
shown that in individualistic cultures, such as the United States, people are more likely to prioritize
outcomes over intentions, while in collectivistic cultures, such as Japan, people are more likely to
prioritize intentions over outcomes. This suggests that understanding cultural differences in intention-
based social preferences is important for developing accurate models of human behavior and making
informed policy decisions.

Overall, intention-based social preferences provide important insights into how individuals make
economic decisions and interact with others. By taking into account not only the outcomes of actions,
but also the intentions behind them, we can gain a more nuanced understanding of human behavior and
develop more effective policies and interventions to promote cooperation and social welfare.

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7.5.3 the possibility of self-deception

Self-deception is a phenomenon in which individuals deceive themselves about their own beliefs or
actions. In the context of behavioral economics, self-deception can influence decision-making and lead
to suboptimal outcomes. The possibility of self-deception arises when individuals have a vested interest
in a particular outcome or belief, and may be motivated to ignore or rationalize information that
contradicts their desired outcome.

The concept of self-deception has been studied extensively in psychology and philosophy, and has
important implications for economic decision-making. For example, individuals may engage in self-
deception when making financial investments, ignoring negative information or rationalizing their
decisions to maintain a positive self-image. This can lead to financial losses and other negative
outcomes.

In addition to financial decision-making, self-deception can also influence social and political behavior.
For example, individuals may engage in self-deception when forming political beliefs, ignoring
information that contradicts their ideological worldview. This can lead to polarization and conflict, as
individuals become increasingly entrenched in their beliefs and unwilling to consider alternative
perspectives.

Despite the potential negative consequences of self-deception, it is a natural and common phenomenon
that can be difficult to overcome. However, awareness of this possibility can help individuals make more
rational and informed decisions. By considering alternative perspectives and actively seeking out
information that challenges their beliefs, individuals can avoid the pitfalls of self-deception and make
more optimal decisions in all aspects of life.

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7.6. Behavioral game theory

Behavioral game theory is an interdisciplinary field that combines game theory, experimental
economics, and experimental psychology to analyze strategic decision-making behavior, including social
preferences, social utility, and psychological factors [2]. It recognizes that people often make decisions
based on emotions, biases, and heuristics and examines how actual human behavior tends to deviate
from standard predictions and models [2].

Traditional game theory assumes rationality, selfishness, and utility maximization, but behavioral game
theory examines how actual human behavior tends to deviate from standard predictions and models [2].
It began with the work of Allais and Ellsberg, and was reinforced by Vernon Smith's work [2].
Experiments have been conducted to understand deviations from rational choice behavior and to
examine emotions and trust in decision-making outcomes [2].

Behavioral game theory recognizes the importance of understanding cognitive biases, loss aversion, and
social norms in designing effective policies [1]. By analyzing how people make decisions in different
situations, it provides a framework for understanding different choices that can be made during diverse
situations among competing players [3]. The practical application of game theory offers valuable tools
that support analyzing and assessing various markets, industries, and other strategic interactions [3].

Studies show that choices are not always rational, and modeling and machine learning are used to
predict and understand behavior in games [2]. Behavioral game theory can be applied to various
scenarios, including business strategy and marketing, allowing firms to design products and services that
are more appealing to consumers [1].

Behavioral game theory also recognizes the importance of social preferences and social utility in
decision-making behavior [2]. Social preferences refer to the consideration of others' welfare, while
social utility refers to the value people place on their relationships with others [2]. By incorporating
these factors into decision-making models, behavioral game theory provides a more accurate
representation of how people make decisions in real-world situations [2].

Another important concept in behavioral game theory is framing effects, which refers to how the way
information is presented can influence decision-making behavior [2]. For example, people may be more
likely to choose an option if it is presented as a gain rather than a loss. By understanding framing effects,
policymakers and businesses can design policies and products that are more effective in achieving their
goals [2].
In summary, behavioral game theory is an interdisciplinary field that combines game theory,
experimental economics, and experimental psychology to analyze strategic decision-making behavior,
including social preferences, social utility, and psychological factors. It recognizes the importance of
understanding cognitive biases, loss aversion, and social norms in designing effective policies and has
implications for business strategy and marketing. By incorporating social preferences, framing effects,
and other factors into decision-making models, behavioral game theory provides a more accurate
representation of how people make decisions in real-world situations.

<b>References:</b>

<span>[1] <a href='https://www.behavioraleconomics.com/resources/mini-encyclopedia-of-be/

behavioral-game-theory/' target='_blank' class='text-purple-1 underline'>(Behavioral) Game
theory</a></span>

<span>[2] <a href='https://en.wikipedia.org/wiki/Behavioral_game_theory' target='_blank' class='text-

purple-1 underline'>Behavioral game theory</a></span>

<span>[3] <a href='https://www.superprof.com/blog/behavioral-economics-decisions/' target='_blank'

class='text-purple-1 underline'>What Is Game Theory In Behavioral Economics? | Superprof</a></span>

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7.7. Nudges, policy and happiness

Nudges are a powerful tool in behavioral economics that can be used to steer people towards making
better decisions. They are designed to gently push people in a particular direction without taking away
their freedom of choice. Nudges can be used in a variety of settings, from healthcare to finance, and can
be used to encourage people to save more money, eat healthier, or exercise more.

One area where nudges have been particularly successful is in public policy. Governments around the
world are using nudges to encourage people to make better decisions about their health, finances, and
environment. For example, in the UK, the government has set up a "Nudge Unit" to help design policy
interventions that are based on behavioral insights.

One of the key benefits of nudges is that they can be very cost-effective. Unlike traditional policy
interventions, nudges don't require a lot of resources to implement. They can also be very quick to
implement, which means that they can be used to address urgent problems.
Another benefit of nudges is that they can be very effective at changing behavior. This is because they
work by tapping into people's unconscious biases and preferences. By making small changes to the
environment in which people make decisions, nudges can make it easier for people to make better
choices.

However, there are also some concerns about the use of nudges in public policy. One concern is that
they may be used to manipulate people's behavior in ways that are not in their best interests. For
example, a nudge that encourages people to opt-in to a particular program could be seen as coercive if
it is presented in a misleading way.

Another concern is that nudges may not be effective for everyone. People who are highly resistant to
change may not respond well to nudges, and some people may even feel offended or insulted by them.
In addition, nudges may not be effective in situations where people have very strong preferences or
beliefs.

Despite these concerns, nudges have the potential to be a powerful tool for policymakers. By using
nudges to encourage people to make better decisions, governments can help to improve public health,
reduce environmental damage, and promote financial stability. As our understanding of behavioral
economics continues to grow, we can expect to see more and more creative uses of nudges in public
policy.

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In behavioral economics, happiness is not simply a subjective state of mind, but rather a complex
concept that can be analyzed and measured in different ways. One approach is to focus on social
preferences, which refer to the ways in which individuals’ happiness is affected by the well-being of
others. Research has shown that people often exhibit distributional social preferences, which means
that they care about the distribution of outcomes across different individuals or groups. For example,
many people are willing to sacrifice some of their own resources in order to reduce inequality or help
those who are less fortunate.

Happiness economics is a field of study that explores the relationship between happiness and economic
factors. It shares some features with behavioral economics, which applies psychological insights into
human behavior to explain economic decisions¹³.
One concept in happiness economics is "habituation," which refers to the fact that people's reported
well-being reverts to a base level, even after major life events such as a disabling injury or winning the
lottery¹⁴. This raises questions about the usefulness of happiness economics in public policy analysis¹.

Behavioral economists have been paying increasing attention to the study of happiness and its
relationship with economic behavior. Research has attempted to address how economically-relevant
behavioral tendencies relate to happiness, and how happiness affects the likelihood of engaging in
certain behaviors³.

Understanding the relationships between happiness and economic behavior is of intrinsic interest to
academics and policymakers. Policymakers concerned with helping people enhance their future
happiness have an interest in knowing which types of behavior exert a positive hedonic effect and are
therefore worth encouraging³.

Source: Conversation with Bing, 6/1/2023

(1) Happiness, Behavioral Economics, and Public Policy | NBER. https://www.nber.org/papers/w19329.

(2) How does happiness relate to economic behaviour? A review of the ....
https://www.sciencedirect.com/science/article/pii/S221480431730037X.

(3) Happiness, Behavioral Economics, and Public Policy - National Bureau of ....
https://www.nber.org/system/files/working_papers/w19329/w19329.pdf.

(4) What are the economics of happiness? | Yale Insights. https://insights.som.yale.edu/insights/what-

are-the-economics-of-happiness.

(5) What Is Behavioral Economics? | Psychology Today.

https://www.psychologytoday.com/us/blog/science-choice/201705/what-is-behavioral-economics.