CandleFocus Glossary Editor
Behavioral economics is a relatively new yet incredibly valuable field of study that examines how psychology and economics intersect in order to understand how people make decisions. Whereas traditional economic models assume people make rational and informed decisions, behavioral economics takes into consideration how psychology and emotion play a role in decision-making. This field of study looks at cognitive bias, bounded rationality, incentives, loss aversion, and herd mentality to explain why people do not always make the most logical choice.
One of the most important concepts in behavioral economics is bounded rationality, which is the idea that people have limited cognitive abilities and must, therefore, make decisions based on limited information and with limited thinking capability. Cognitive bias and heuristics are further related to bounded rationality as they refer to the tendency of people to take shortcuts in their decision making and allow their past experiences to influence their current choices.
Herd mentality is another important factor in behavioral economics. This is the tendency for people to make decisions in the same way that other people around them are making decisions. For example, following the crowd in order to not stand out, or to trust the crowd's opinion even when it is not correct.
The way companies package their products, determine pricing, and craft their commercials is also subject to behavior economics. Companies take into account different factors, such as the concept of framing and the sunk-cost fallacy, and use them to their advantage. For example, Starbucks often introduces limited edition drinks to create an artificial scarcity and encourage customers to buy them quickly. Amazon also regularly sends out emails promoting “Lightning Deals” and “buy one, get one” promotions to gain customer attention.
Behavioral economics is an important and useful field of study that continues to gain traction among economists and businesses alike. By taking into account cognitive biases, bounded rationality, herd mentality, and other psychological aspects of decision-making, behavioral economics gives us a much more accurate understanding of how people choose and why they make the choices they do. Companies can then use this data to better tailor their promotions and offerings to their target customers, allowing them to make more informed business decisions.
One of the most important concepts in behavioral economics is bounded rationality, which is the idea that people have limited cognitive abilities and must, therefore, make decisions based on limited information and with limited thinking capability. Cognitive bias and heuristics are further related to bounded rationality as they refer to the tendency of people to take shortcuts in their decision making and allow their past experiences to influence their current choices.
Herd mentality is another important factor in behavioral economics. This is the tendency for people to make decisions in the same way that other people around them are making decisions. For example, following the crowd in order to not stand out, or to trust the crowd's opinion even when it is not correct.
The way companies package their products, determine pricing, and craft their commercials is also subject to behavior economics. Companies take into account different factors, such as the concept of framing and the sunk-cost fallacy, and use them to their advantage. For example, Starbucks often introduces limited edition drinks to create an artificial scarcity and encourage customers to buy them quickly. Amazon also regularly sends out emails promoting “Lightning Deals” and “buy one, get one” promotions to gain customer attention.
Behavioral economics is an important and useful field of study that continues to gain traction among economists and businesses alike. By taking into account cognitive biases, bounded rationality, herd mentality, and other psychological aspects of decision-making, behavioral economics gives us a much more accurate understanding of how people choose and why they make the choices they do. Companies can then use this data to better tailor their promotions and offerings to their target customers, allowing them to make more informed business decisions.