Behavioral Economics: Understanding Irrational Economic Decision – Making

Abstract

Behavioral economics, a subfield of economics that integrates insights from psychology and other social sciences, seeks to understand and explain the often irrational decision-making processes of individuals in economic contexts. This interdisciplinary approach challenges traditional economic models that assume individuals always act rationally and in their best interest. This abstract provides an overview of key concepts and findings in behavioral economics, shedding light on the various cognitive biases and heuristics that influence economic decision-making. The foundation of behavioral economics lies in recognizing that humans frequently deviate from the assumptions of classical economic theory. Prospect theory, developed by Daniel Kahneman and Amos Tversky, is a pivotal framework in understanding how individuals evaluate potential gains and losses. Loss aversion, a central tenet of prospect theory, posits that losses loom larger than equivalent gains, influencing decisions in areas such as investment and risk-taking. Another significant aspect of behavioral economics is bounded rationality, which acknowledges that individuals have limited cognitive resources and often rely on heuristics or mental shortcuts to make decisions. This can lead to systematic errors, such as anchoring (relying too heavily on the first piece of information encountered) or availability heuristic (placing greater importance on readily available information).