Select your language

Suggested languages for you:
Log In Start studying!
StudySmarter - The all-in-one study app.
4.8 • +11k Ratings
More than 3 Million Downloads
Free
|
|

All-in-one learning app

  • Flashcards
  • NotesNotes
  • ExplanationsExplanations
  • Study Planner
  • Textbook solutions
Start studying

Aspects of Behavioural Economic Theory

Save Save
Print Print
Edit Edit
Sign up to use all features for free. Sign up now
Economics

How do you make decisions? What are some of the factors that influence your decision? How long does it take for you to decide something important? Are you able to make rational choices that best maximise your outcome based on the constraints that you have?

Behavioural economics is all about how people make decisions and what influences their decisions. Behavioural economics’ main argument is that human beings are not always rational, and there are certain factors that influence their decisions. In this explanation, you will learn everything you need to know about behavioural economics.

Behavioural economics explained

Behavioural economics uses psychology and economic theory to draw new explanations on how human beings choose to interact in an economy. It aims to provide an alternative to conventional economic theory, which assumes that all humans are rational and that their decisions are always optimal.

Rational choice theory suggests that when individuals are faced with many choices and constraints, each individual is reasonable enough to make the choice that best maximises their gains.

Behavioural economists challenge this rational choice theory and argue that, in reality, humans are not always rational decision markers due to many constraints, which we will discuss later.

Behavioural economics takes into account other aspects of an individual, such as their social norms, habits, personality, etc. It does so by taking into account psychological factors that might play a role in encouraging an individual to choose one option over another.

Think about it. To what extent do your social norms dictate your consumption? An individual’s psychology influences all their choices to a certain extent.

Julie goes to a university in London. She is an aspiring engineer, and she aims to graduate top of her class. Julie has to allocate most of her time to study to achieve this.

To stay at the top of her class, Julie needs to study about 10 hours a day. The rational choice theory would suggest that Julie would study 10 hours and dedicate the rest of her time to other activities.

However, her friends tell her to cancel her study plans and join them in exploring the city instead. At some point, Julie will be influenced by her and her friends’ desires to go out.

Rational decision-making

Behavioural economics challenges the idea that humans can make rational decisions that would allow them to maximise their gains based on a number of constraints. There are two perspectives behavioural economics provide that challenge the rationality of human beings:

  1. Bounded rationality.
  2. Bounded self-control.

Bounded rationality

Behavioural economists argue that there are many restrictions on people’s ability to make rational decisions and this causes them to act in an irrational way.

Bounded rationality is the idea that individuals have limits on decision making and these limits hinder their ability to make sound rational decisions all the time.

Think about it. You are different to your friends. You may perceive things in a different way, and that is true of everyone else in the world. We all have a varying degree of perception, intelligence, skills etc. that influence the way we think and make decisions.

Bounded rationality theory suggests that there are three limitations to individual choices:

  1. Limited information. We all face limited information or inaccurate information about something and this could cause us to make an irrational decision.
  2. Mental capacity. Not all of us are able to process vast amounts of data/information to make a decision and this limits our ability to make rational choices.
  3. Time constraints. There may not be enough time to weigh in all the alternatives and explore all the possible choices and make a rational decision.

Bounded self-control

Another aspect behavioural economists challenge is the idea that all individuals have total self-control.

Bounded self-control is the idea that individuals have limits on their self-control and these limits hinder their ability to maximise their utility.

Bounded self-control suggests that there are limits to the extent individuals can commit to a choice that would be in their best interest. Therefore, this affects whether or not they can make rational decisions.

Thinking fast and slow

Another interesting point behavioural economists make is that different decisions require different amounts of time.

Thinking fast and thinking slow refers to the time it takes for an individual to decide based on the type of decision they have to make.

When you crave a milkshake, you go buy it. But the same thing doesn’t apply to enrolling in a university. You take the time to think and process what you want to do in life, what career you choose, etc.

Biases in decision-making

Many factors influence the decision-making of an individual. It could be their past experiences and the weight they attribute to past even. It could be their tastes. All these contribute to us making biased decisions. Some of the biases in decision-making are:

  1. Availability bias
  2. Anchoring
  3. Bias based on social norms
  4. Habitual behaviour
  5. Rule of thumb

Before we look at each of these, let’s define bias.

Bias is an irrational assumption or belief that affects the ability to make a decision based on facts.

Keep this definition in mind as we look at each bias in decision making.

Availability bias

Availability bias occurs when an individual uses outcomes of other similar events to make their own decisions.

You visit a restaurant that your friends continually praise. Because you know of people who has a good experience at this restaurant, you expect good food. You might not have even considered other options or the money or the cost of eating at that restaurant, but you place a large order, knowing that the food is going to be good.

In this example, you have considered similar events and made decisions based on them. Whether intentional or not, you have made a biased decision.

Anchoring

Anchoring is based on an obsession with a particular piece of information.

Anchoring occurs when individuals give too much weight to the first or one piece of information they have received.

The first piece of information becomes a reference point for the individual to decide.

You see a cool jacket on sale at a shop. You try negotiating with the salesperson on the price of the jacket, and they quote you the first price of £50. You think this is a fair price and buy it.

In this example, the salesperson would’ve accepted lower, but your thought about how much lower £50 was in comparison to the original price that you forgot about negotiating an even lower price and bought it.

Biases based on social norms

The social setting an individual lives in has a lot to do with how they make decisions. Living in a social setting where social norms encourage certain behaviours, will influence an individual to acquire such behaviours.

Some social norms encourage alcohol consumption, which causes alcohol to be widely accepted in many societies.

However, drinking a lot of alcohol might not be the most rational decision due to its health impacts and the impacts on other third parties.

Habitual behaviour

Habitual behaviour includes a routine of behaviours of certain individuals.

You drink coffee every morning at your local shop instead of having it at home. Although this might not be the most rational decision if you're trying to save money, you will still make it because it’s a habit.

Rule of thumb

Rule of thumb refers to the already established guides on the behaviours that are appropriately relevant to a certain setting. There are unofficial agreements or codes of behaviour that individuals should follow.

There are some rules of thumb in finance that give guidance on how much you need to save for a mortgage.

Behavioural economics applications

Behavioural economics has applications in all aspects of life. We don’t necessarily have to engage in an economic transaction for behavioural economics to be applicable in our lives. Let’s consider two examples:

  1. At school or work

    When you go to work or school, there are certain behaviours that have already been established, that influence the decisions you make.

    For instance, you wouldn’t drink while at work.
  2. When shopping

    Gucci and other expensive brands charge really high prices, but most customers come from the upper-middle-income class rather than significantly wealthy people. People associate Gucci with the rich, and they buy it because they believe it says something about them. The high prices make brands like Gucci look exclusive, which pushes people to buy them.

Aspects of Behavioural Economic Theory - Key takeaways

  • Behavioural economics uses psychology and economic theory to draw new explanations on how humans interact in an economy.
  • Behavioural economics aims to provide an alternative to conventional economic theory, which assumes that all humans are rational and that their decisions are always optimal.
  • Behavioural economics suggests that individuals have bounded rationality and bounded self-control, which limits their ability to make rational decisions.
  • Biases in decision making include availability bias, anchoring, biases based on social norms, habitual behaviour, and the rule of thumb bias.
  • Behavioural economics can be applied in our daily lives, not just when making economic transactions.

Aspects of Behavioural Economic Theory

When consumers buy a certain brand due to the influence of social norms in a region.

Behavioural economists combine psychology with economic theory to provide explanations on how humans make decisions.

The main ideas of behavioural eonomics are: 

  • Humans don’t always make rational choices.
  • There are biases involved in the process of decision-making.

Final Aspects of Behavioural Economic Theory Quiz

Question

What is behavioural economics?

Show answer

Answer

It’s the study of human behaviour using psychological and economic theories.

Show question

Question

What disciplines does behavioural economics combine?

Show answer

Answer

Psychology and Economics

Show question

Question

What's the aim of behavioural economics?

Show answer

Answer

It aims to provide an alternative to conventional economic theory, which assumes that all human beings are rational and that their decisions are always optimal.

Show question

Question

What does the rational choice theory suggest?

Show answer

Answer

Rational choice theory suggests that when individuals are faced with many choices and constraints, each individual is reasonable enough to make the choice that best maximizes their gains.

Show question

Question

Give some examples that behavioural economics takes into account when studying human behaviour.

Show answer

Answer

Behavioural economics takes into account other aspects of an individual, such as their social norms, habits, personality, etc.

Show question

Question

What are some of the factors that influence rational decision making according to behavioural economic theory?

Show answer

Answer

Behavioural economics suggests that bounded rationality, bounded self control, and the time it takes to come up with a decision influence rational decision making.

Show question

Question

Name three biases in decision making.

Show answer

Answer

Biases in decision making include: availability bias, anchoring, biases based on social norms, habitual behaviour, and rule of thumb.

Show question

Question

What is bounded rationality theory?

Show answer

Answer

Bounded rationality theory suggests that there are certain limitations that human beings face when making choices. Because of these limitations they are incapable of making rational decisions.

Show question

Question

What are the three constraints proposed by the bounded rationality theory?

Show answer

Answer

Bounded rationality theory suggests that there are three limitations to individual choices. Firstly, an individual will face limited information about their available choice and other alternatives that could exist out there. Secondly, the mental capacity of one will always influence their choice, whether they are genius or not. Thirdly, every individual is faced with a time constraint to make a choice. 

Show question

Question

Explain bounded self-control.

Show answer

Answer

We all have different levels of self-control. Imagine you want to lose weight, but you are obsessed with chocolate. To what extent can you refrain from eating chocolates to lose weight? Bounded self-control suggests that there are limits to the extent individuals can commit to a choice that would be in their best interest. Therefore, this affects whether or not they can make rational decisions.

Show question

Question

Explain the time it takes to think a decision through in terms of influencing rational choices.

Show answer

Answer

Thinking fast and thinking slow refers to the time it takes for an individual to decide based on the type of decision they have to make. When you crave a milkshake, you go buy it. But the same thing doesn’t apply to enrolling in a university. You take the time to think and process what you want to do in life, what career you choose, etc.


Show question

Question

What is availability bias?

Show answer

Answer

Availability bias occurs when an individual uses outcomes of other similar events to make their own decisions. Think how many times you’ve been to a new restaurant just because other people had a good experience at that restaurant.

Show question

Question

What is anchoring?

Show answer

Answer

Anchoring happens when individuals give too much weight to the first pieces of information they receive. The first pieces of information then become a reference point for the individual to decide. As it is something one is firstly introduced with, it creates biases as other alternatives were not explored. 

Show question

Question

Explain biases based on social norms.

Show answer

Answer

The social setting an individual lives in has a lot to do with how they make decisions. Living in a social setting where social norms encourage certain behaviors, an individual will end up acquiring such behaviors. 

Show question

Question

Explain habitual behaviour.

Show answer

Answer

Habitual behaviour refers to routine behaviors of certain individuals. 

Show question

Question

Give examples of habitual behaviour that create biases in decision making.

Show answer

Answer

One example could be drinking coffee every morning at your local shop. Although this might not be the most rational decision to make, you will still make it because it’s a habit. 

Show question

Question

Explain the rule of thumb bias.

Show answer

Answer

Rule of thumb refers to the already established guides on the behaviours that are appropriately relevant to a certain setting. Rule of thumb refers to unofficial agreements or codes of behavior that individuals should follow.

Show question

Question

When individuals are faced with many choices and constraints, each individual is reasonable enough to make the choice that best maximises their gains. This is called

Show answer

Answer

Rational choice theory

Show question

Question

Behavioural economics takes into account other aspects of an individual, such as their social norms, habits, personality, etc. 

Show answer

Answer

True

Show question

Question

Behavioural economics takes into account, the psychological factors that influence a person's choice. 

Show answer

Answer

True

Show question

Question

What are the two perspectives behavioral economics provides?

Show answer

Answer

  1. Bounded rationality.
  2. Bounded self-control.

Show question

Question

The idea that individuals have limits on decision making and these limits hinder their ability to make sound rational decisions all the time is called 

Show answer

Answer

Bounded rationality

Show question

Question

Limited information, __________, and ___________ are the limitations of bounded rationality.

Show answer

Answer

mental capacity, and time constraints

Show question

Question

The idea that individuals have limits on their self-control and these limits hinder their ability to maximise their utility is called

Show answer

Answer

Bounded self-control  

Show question

Question

Some of the biases in decision making are.

  1. ____________
  2. Anchoring
  3. ____________
  4. ____________
  5. Rule of thumb 


Show answer

Answer

  1. Availability bias
  2. Anchoring
  3. Bias based on social norms
  4. Habitual behaviour
  5. Rule of thumb 


Show question

Question

______ is an irrational assumption or belief that affects the ability to make a decision based on facts. 

Show answer

Answer

Bias

Show question

Question

_________ occurs when an individual uses outcomes of other similar events to make their own decisions.  

Show answer

Answer

Availability bias

Show question

Question

When individuals give too much weight to the first or one piece of information they have received, this is called habitual behaviour

Show answer

Answer

True

Show question

Question

__________ refers to the already established guides on the behaviours that are appropriately relevant to a certain setting. 

Show answer

Answer

Rule of thumb

Show question

Question

What is an example of anchoring?

Show answer

Answer

You see a cool jacket on sale at a shop. You try negotiating with the salesperson on the price of the jacket, and they quote you the first price of £50. You think this is a fair price and buy it. 

Show question

60%

of the users don't pass the Aspects of Behavioural Economic Theory quiz! Will you pass the quiz?

Start Quiz

Discover the right content for your subjects

No need to cheat if you have everything you need to succeed! Packed into one app!

Study Plan

Be perfectly prepared on time with an individual plan.

Quizzes

Test your knowledge with gamified quizzes.

Flashcards

Create and find flashcards in record time.

Notes

Create beautiful notes faster than ever before.

Study Sets

Have all your study materials in one place.

Documents

Upload unlimited documents and save them online.

Study Analytics

Identify your study strength and weaknesses.

Weekly Goals

Set individual study goals and earn points reaching them.

Smart Reminders

Stop procrastinating with our study reminders.

Rewards

Earn points, unlock badges and level up while studying.

Magic Marker

Create flashcards in notes completely automatically.

Smart Formatting

Create the most beautiful study materials using our templates.

Sign up to highlight and take notes. It’s 100% free.