🔬 Behavioural Economics
Definition: Behavioural economics studies how real humans actually make decisions, rather than how the rational model assumes they do.
Bounded rationality
Herbert Simon argued that people are boundedly rational — they TRY to be rational but face limits: limited information, limited time, and limited brainpower. Instead of finding the BEST option, they settle for one that is 'good enough'. This is called satisficing.
Think of choosing a restaurant. You do not check every restaurant in the city and rank them — you pick one that seems good enough. That is satisficing.
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🧩 Key Biases You Need to Know
Anchoring
People rely too heavily on the first piece of information they receive. A shop that shows a 'was $100, now $60' tag anchors you to $100, making $60 feel like a bargain — even if the product was never really worth $100.
Framing
The way a choice is presented affects the decision. '95% fat-free' sounds much better than 'contains 5% fat' — same information, different reaction. Framing violates the rational model because a rational agent would treat both the same.
More important biases
- Status quo bias — people stick with defaults (e.g. staying on an expensive phone plan)
- Loss aversion — the pain of losing $100 feels roughly TWICE as strong as the pleasure of gaining $100
- Optimism bias — people underestimate risks to themselves ('it won't happen to me')
- Herding — following what others do instead of thinking independently (stock market bubbles)
For the exam, you need to be able to NAME a bias, EXPLAIN it, and give a REAL-WORLD EXAMPLE. Practice linking biases to consumer or producer decisions.
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📏 Rules of Thumb (Heuristics)
Because full rational analysis is costly and slow, people use heuristics — quick mental shortcuts.
- 'If the brand is well-known, it must be good' (availability heuristic)
- 'I always buy this product, so it must still be the best option' (habit)
- 'Everyone else is buying it, so it must be worth it' (social proof)
- 'The more expensive option is probably better quality' (price-quality heuristic)
Why this matters for economics: If consumers use heuristics instead of rational calculation, they may not respond to price changes in the way the demand curve predicts. This weakens the predictive power of the basic model.