Behavioral Economics

1. Behavioral Economics A branch of economics that studies the psychology of decision-making to explain consumer behavior.

2. Behavioral Economics • Similarities with standard economics: • Individuals are assumed to have well-defined agendas • Rely on mathematical models of behavior • Test theories empirically

3. Behavioral Economics • Differences from standard economics: • Focus on how consumers make decisions • Inclusion of attitudes towards fairness and status • Greater use of experiments • Focus on when behavior deviates from the standard theory • No single unifying theory

4. Incoherent Choices Reference point – The point from which a person makes a consumption decision

5. Incoherent Choices Anchoring – when choices are linked to prominent but patently irrelevant information

6. Incoherent Choices, cont. Endowment effect – when people tend to value something more highly when they own it than when they don’t

7. Incoherent Choices, cont. Default effect – when confronted with many choices people sometimes avoid making a choice and taking the default option

8. Incoherent Choices, cont. Narrow framing – the tendency to group related items into categories, and, in making a choice consider items in the same category while ignoring items in different categories

9. Imagine that you have decided to see a play where admission is $10 per ticket. As you enter the theater you discover that you have lost a $10 bill. Would you still pay $10 for ticket for the play?

10. Imagine you have decided to see a play and paid the admission price of $10 per ticket. As you enter the theater you discover that you have lost the ticket. The seat was not market and the ticket cannot be recovered. Would you pay $10 for another ticket?

11. Rules of Thumb When a generalized rule is used to set strategy when faced with a complex set of choices.

12. Social Motives A prize of $100 has been given to Fred. He will make an offer to share the prize with you. If you accept the offer Fred gets to keep his share of the prize, if you don’t accept he loses the prize. Fred offers to give you $5, would you take it? You will only play this game once.

13. Social Motives Ultimatum game – one player offers to give a second player some share of a fixed prize, the second player then decides to accept or reject the proposal. Dictator game – a player divides a fixed prize between himself and another player who is a passive participant.

14. Neuroeconomics Studies the human neural system with the object of discovering new principles of economic decision making

15. Neuroeconomics • Much of the brain implements “automatic” processes, which are faster than conscious deliberations • Behavior is strongly influenced • by finely tuned affective (emotion) • systems