Behavioral Economics is a field that uses psychological and sociological reasoning to analyze an economy. It has significant overlap with behavioral finance, with slightly different application. Market decisions and public choices are concerns for behavioral economists. Behavioral economists look at heuristics (generalized rules that people follow), framing (the way that economic decisions are presented to those making the decision), and market inefficiencies (when the agents (consumers and producers) of the market behave in irrational ways; i.e., people consistently buying a higher-priced version of a product without any obvious differences between the products).

Heuristics can be seen in a lot of human knowledge. They are represented informally as "rules of thumb", generalizations that are true more often than not. When heuristics are applied outside their scope -- when someone makes the assumption that, for example, a third-world farmer is going to choose from the same crops that a farmer in the Midwestern United States would - they can result in irrational decisions.

The way a decision is framed refers to how it is put to the decider. A classic explanation is contained in the 'Asian disease' experiment. In it, two groups of people were given the following scenario: Given an outbreak, and 600 people who are going to die, which plan should be implemented? After asking this question, the first group are given the choice of plan A, which will save 200 people, or plan B, which gives 1/3rd of a chance that 600 people will be saved, and a 2/3rds chance that none of them will be saved. The second group are given the same choices, but worded differently. Plan A is now described as '400 people will die', and plan B is now described as "1/3rd chance that everyone will be saved, but a 2/3rds chance that all 600 will die." In the first group, 72% of participants chose option A. However, in the second group, 78% of participants chose option B. A few moments of mathematical reflection proves that they're identical, but the way they are framed makes A or B more or less attractive.

These occur when irrational decisions appear to be made, or when information is not widely available to all agents within an economic system. Some examples include when items are priced much higher or lower than the market would predict, when consumers purchase a product despite there being cheaper, similarly effective competing products that are just as well-known, or when sales of a product or service are drastically different from what the market would suggest. Negative press, brand loyalty, and collective greed can all influence the activity of the market in a way that cannot be explained through simple technical data.

Economics | Economists | Psychology | Logic | Free Market