Editing Behavioral economics (section)

== Concepts ==
Behavioral economics aims to improve or overhaul traditional economic theory by studying failures in its assumptions that people are rational and selfish. Specifically, it studies the biases, tendencies and heuristics of people's economic decisions. It aids in determining whether people make good choices and whether they could be helped to make better choices. It can be applied both before and after a decision is made.

=== Search heuristics ===

Behavioral economics proposes search heuristics as an aid for evaluating options. It is motivated by the fact that it is costly to gain information about options and it aims to maximise the [[utility]] of searching for information. While each heuristic is not wholistic in its explanation of the search process alone, a combination of these heuristics may be used in the decision-making process. There are three primary search heuristics.

'''Satisficing'''

[[Satisficing]] is the idea that there is some minimum requirement from the search and once that has been met, stop searching. After satisficing, a person may not have the most optimal option (i.e. the one with the highest utility), but would have a "good enough" one. This heuristic may be problematic if the aspiration level is set at such a level that no products exist that could meet the requirements.

'''Directed cognition'''

Directed cognition is a search heuristic in which a person treats each opportunity to research information as their last. Rather than a contingent plan that indicates what will be done based on the results of each search, directed cognition considers only if one more search should be conducted and what alternative should be researched.

'''Elimination by aspects'''

Whereas satisficing and directed cognition compare choices, elimination by aspects compares certain qualities. A person using the elimination by aspects heuristic first chooses the quality that they value most in what they are searching for and sets an aspiration level. This may be repeated to refine the search. i.e. identify the second most valued quality and set an aspiration level. Using this heuristic, options will be eliminated as they fail to meet the minimum requirements of the chosen qualities.<ref>{{Cite web| title=Elimination by aspects: A theory of choice|last=Tversky|first= A|date=May 16, 2023 | url=https://www.behavioraleconomics.com/resources/mini-encyclopedia-of-be/elimination-by-aspects/}}</ref>

=== Heuristics and cognitive effects ===
Besides searching, behavioral economists and psychologists have identified other [[heuristics]] and other cognitive effects that affect people's decision making. These include:

'''Mental accounting'''

[[Mental accounting]] refers to the propensity to allocate resources for specific purposes. Mental accounting is a behavioral bias that causes one to separate money into different categories known as mental accounts either based on the source or the intention of the money.<ref>{{Cite web|last=behavioralecon|title=Mental accounting|url=https://www.behavioraleconomics.com/resources/mini-encyclopedia-of-be/mental-accounting/|access-date=2020-09-21|website=BehavioralEconomics.com {{!}} The BE Hub|language=en-US}}</ref>

'''Anchoring'''

[[Anchoring (cognitive bias)|Anchoring]] describes when people have a mental reference point with which they compare results to. For example, a person who anticipates that the weather on a particular day would be raining, but finds that on the day it is actually clear blue skies, would gain more utility from the pleasant weather because they anticipated that it would be bad.<ref>{{Cite web|title=Anchoring Bias - Definition, Overview and Examples|url=https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/anchoring-bias/|access-date=2020-09-21|website=Corporate Finance Institute|language=en-US}}</ref>

'''Herd behavior'''

This is a relatively simple bias that reflects the tendency of people to mimic what everyone else is doing and follow the general consensus.

'''Framing effects'''

People tend to choose differently depending on how the options are presented to them. People tend to have little control over their susceptibility to the framing effect, as often their choice-making process is based on intuition.<ref>{{cite book |last1=Cartwright |first1=Edward |title=Behavioral economics |date=2018 |location=Abingdon, Oxon |publisher=Routledge |isbn=9781138097117 |page=45 |edition=Third}}</ref>

=== Biases and fallacies ===

While heuristics are tactics or mental shortcuts to aid in the decision-making process, people are also affected by a number of [[biases]] and [[fallacies]]. Behavioral economics identifies a number of these biases that negatively affect decision making such as:

'''Present bias'''

[[Present bias]] reflects the human tendency to want rewards sooner. It describes people who are more likely to forego a greater payoff in the future in favour of receiving a smaller benefit sooner. An example of this is a smoker who is trying to quit. Although they know that in the future they will suffer health consequences, the immediate gain from the nicotine hit is more favourable to a person affected by present bias. Present bias is commonly split into people who are aware of their present bias (sophisticated) and those who are not (naive).<ref>O'Donoghue, Ted, and Matthew Rabin. 2015. "Present Bias: Lessons Learned and to Be Learned." American Economic Review, 105 (5): 273-79.</ref>

'''Gambler's fallacy'''

The [[gambler's fallacy]] stems from [[Hasty generalisation|law of small numbers]].<ref>{{cite book |last1=Cartwright |first1=Edward |title=Behavioral economics |date=2018 |publisher=Taylor & Francis Group |location=Abingdon, Oxon |isbn=9781138097117 |page=216 |edition=Third}}</ref> It is the belief that an event that has occurred often in the past is less likely to occur in the future, despite the probability remaining constant. For example, if a coin had been flipped three times and turned up heads every single time, a person influenced by the gambler's fallacy would predict that the next one ought to be tails because of the abnormal number of heads flipped in the past, even though the probability of a heads occurring is still 50%.<ref>{{Cite journal |last1=Croson |first1=Rachel |last2=Sundali |first2=James |date=2005-05-01 |title=The Gambler's Fallacy and the Hot Hand: Empirical Data from Casinos |url=https://link.springer.com/article/10.1007/s11166-005-1153-2 |journal=Journal of Risk and Uncertainty |language=en |volume=30 |issue=3 |pages=195–209 |doi=10.1007/s11166-005-1153-2 |issn=1573-0476}}</ref>

'''Hot hand fallacy'''

The hot hand fallacy is the opposite of the gambler's fallacy. It is the belief that an event that has occurred often in the past is more likely to occur again in the future such that the streak will continue. This fallacy is particularly common within sports. For example, if a football team has consistently won the last few games they have participated in, then it is often said that they are 'on form' and thus, it is expected that the football team will maintain their winning streak.<ref name="Cartwright">{{cite book |last1=Cartwright |first1=Edward |title=Behavioral economics |date=2018 |location=Abingdon, Oxon |publisher=Routledge |isbn=9781138097117 |page=217 |edition=Third}}</ref>

'''Narrative fallacy'''

Narrative fallacy refers to when people use narratives to connect the dots between random events to make sense of arbitrary information. The term stems from Nassim Taleb's book ''[[The Black Swan: The Impact of the Highly Improbable]]''. The narrative fallacy can be problematic as it can lead to individuals making false cause-effect relationships between events.<ref>{{cite journal |last1=Yesudian |first1=R. I. |last2=Yesudian |first2=P. D. |title=Case reports and narrative fallacies: the enigma of black swans in dermatology |journal=Clinical and Experimental Dermatology |date=27 November 2020 |volume=46 |issue=4 |pages=641–645 |doi=10.1111/ced.14504|pmid=33245798 |s2cid=227191908 }}</ref> For example, a startup may get funding because investors are swayed by a narrative that sounds plausible, rather than by a more reasoned analysis of available evidence.<ref>{{Cite web|title=Narrative Fallacy - Definition, Overview and Examples in Finance|url=https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/narrative-fallacy/|access-date=2021-06-26|website=Corporate Finance Institute|language=en-US}}</ref>

'''Loss aversion'''

[[Loss aversion]] refers to the tendency to place greater weight on losses compared to equivalent gains. In other words, this means that when an individual receives a loss, this will cause their utility to decline more so than the same-sized gain.<ref>{{cite book |last1=Cartwright |first1=Edward |title=Behavioral economics |date=2018 |location=Abingdon, Oxon |publisher=Routledge |isbn=9781138097117 |page=47 |edition=Third}}</ref> This means that they are far more likely to try to assign a higher priority on avoiding losses than making investment gains. As a result, some investors might want a higher payout to compensate for losses. If the high payout is not likely, they might try to avoid losses altogether even if the investment's risk is acceptable from a rational standpoint.<ref>{{Cite web|last=Kenton|first=Will|title=Behavioral Finance Definition|url=https://www.investopedia.com/terms/b/behavioralfinance.asp|access-date=2020-09-21|website=Investopedia|language=en}}</ref>

'''Recency bias'''

[[Recency bias]] is the belief that a particular outcome is more probable simply because it had just occurred. For example, if the previous one or two flips were heads, a person affected by recency bias would continue to predict that heads would be flipped.<ref>{{Cite web|url=https://www.imcusa.org/blogpost/334056/136102/721-Use-Cognitive-Biases-to-Your-Advantage#:~:text=Recency%20Bias%20%2D%20giving%20greater%20importance,made%20has%20a%20slight%20advantage)|title=''Use Cognitive Biases to Your Advantage'', Institute for Management Consultants, #721, December 19, 2011|access-date=November 1, 2020|archive-date=October 24, 2020|archive-url=https://web.archive.org/web/20201024151714/https://www.imcusa.org/blogpost/334056/136102/721-Use-Cognitive-Biases-to-Your-Advantage#:~:text=Recency%20Bias%20%2D%20giving%20greater%20importance,made%20has%20a%20slight%20advantage)|url-status=dead}}</ref>

'''Confirmation bias'''

[[Confirmation bias]] is the tendency to prefer information consistent with one's beliefs and discount evidence inconsistent with them.<ref>{{cite book |last1=Cartwright |first1=Edward |title=Behavioral economics |date=2018 |location=Abingdon, Oxon |publisher=Routledge |isbn=9781138097117 |page=213 |edition=Third}}</ref>

'''Familiarity bias'''

Familiarity bias simply describes the tendency of people to return to what they know and are comfortable with. Familiarity bias discourages affected people from exploring new options and may limit their ability to find an optimal solution.<ref>{{Cite web|title=10 cognitive biases that can lead to investment mistakes|url=http://www.magellangroup.com.au/insights/10-cognitive-biases-that-can-lead-to-investment-mistakes/|access-date=2020-09-21|website=Magellan Financial Group|language=en}}</ref>

'''Status quo bias'''

[[Status quo bias]] describes the tendency of people to keep things as they are. It is a particular aversion to change in favor of remaining comfortable with what is known.<ref>{{ Cite journal| last= Dean|first= M.|title=Limited attention and status quo bias. Journal of Economic Theory pp93-127|journal= Journal of Economic Theory|year= 2017|volume= 169|issue= C|pages= 93–127|doi= 10.1016/j.jet.2017.01.009|hdl= 10419/145423|url=https://econpapers.repec.org/article/eeejetheo/v_3a169_3ay_3a2017_3ai_3ac_3ap_3a93-127.htm|hdl-access= free}}</ref>

Connected to this concept is the [[endowment effect]], a theory that people value things more if they own them - they require more to give up an object than they would be willing to pay to acquire it.<ref>{{cite web | url=https://thedecisionlab.com/reference-guide/economics/the-endowment-effect | title=The Endowment Effect }}</ref>