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Behavioral Economics

Behavioral economics is a field of study that combines psychology and economics to understand how people make decisions in the real world.

Traditional economics assumes that people are rational actors who always make decisions in their own best interest.

Behavioral economics recognizes that people are often influenced by a variety of factors, such as emotions, biases, and social norms. So people may make decisions that are not necessarily optimal from an economic standpoint.

For example, people may be more likely to buy a product if it is on sale, even if the discount is small. This is because people are more sensitive to losses than gains, a phenomenon known as loss aversion. People may be more likely to trust a product that is endorsed by a celebrity, even if there is no evidence that the product is actually better than its competitors. This is because people are susceptible to social influence.

Behavioral economics has a wide range of applications, from business to government policy. Businesses can use behavioral economics to design marketing campaigns that are more likely to be effective. Governments can use behavioral economics to design policies that encourage people to make positive choices.

Behavioral economics challenges traditional economics and acknowledges that people make decisions influenced by emotions, biases, and limited information processing. Behavioral economics argues that people have limitations in their ability to gather and process information. We often rely on mental shortcuts (heuristics) which can lead to biases. These biases are results of systematic errors in our thinking.

Daniel Kahneman in his book "Thinking, Fast and Slow" describes two modes of human thought.

  • System 1: Fast, instinctive and emotional. This is our automatic thinking system, which operates quickly and without much effort. It is responsible for many of our everyday decisions and judgments, such as recognizing a friend's face or avoiding a speeding car.
  • System 2: Slower, more deliberative, and more logical. This is our conscious thinking system, which is used for more complex tasks that require effort and concentration. It is responsible for tasks such as solving math problems or making important decisions.
Kahneman argues that System 1 is often in control of our thoughts and behaviors, and that System 2 is lazy and tends to avoid exerting effort unless forced to. This can lead to a number of biases in our thinking.

In summary, we are often not as rational as we think we are. Our decisions are often influenced by biases and heuristics that we are not even aware of. System 1 can be a powerful tool, but it can also lead us astray. It is important to be aware of the limitations of System 1 and to use System 2 more often when making important decisions.

References:
1. "Thinking, Fast and Slow"- Daniel Kahneman
2. https://sabeconomics.org/

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