Behavioral economicsBehavioral economics studies the effects of psychological, cognitive, emotional, cultural and social factors in the decisions of individuals or institutions, and how these decisions deviate from those implied by classical economic theory. Behavioral economics is primarily concerned with the bounds of rationality of economic agents. Behavioral models typically integrate insights from psychology, neuroscience and microeconomic theory. The study of behavioral economics includes how market decisions are made and the mechanisms that drive public opinion.
Decision-makingIn psychology, decision-making (also spelled decision making and decisionmaking) is regarded as the cognitive process resulting in the selection of a belief or a course of action among several possible alternative options. It could be either rational or irrational. The decision-making process is a reasoning process based on assumptions of values, preferences and beliefs of the decision-maker. Every decision-making process produces a final choice, which may or may not prompt action.
Expected utility hypothesisThe expected utility hypothesis is a popular concept in economics that serves as a reference guide for decision making when the payoff is uncertain. The theory describes which options rational individuals should choose in a situation with uncertainty, based on their risk aversion. The expected utility hypothesis states an agent chooses between risky prospects by comparing expected utility values (i.e. the weighted sum of adding the respective utility values of payoffs multiplied by their probabilities).
Decision theoryDecision theory (or the theory of choice; not to be confused with choice theory) is a branch of applied probability theory and analytic philosophy concerned with the theory of making decisions based on assigning probabilities to various factors and assigning numerical consequences to the outcome. There are three branches of decision theory: Normative decision theory: Concerned with the identification of optimal decisions, where optimality is often determined by considering an ideal decision-maker who is able to calculate with perfect accuracy and is in some sense fully rational.
Loss aversionLoss aversion is a psychological and economic concept which refers to how outcomes are interpreted as gains and losses where losses are subject to more sensitivity in people's responses compared to equivalent gains acquired. Kahneman and Tversky (1992) have suggested that losses can be twice as powerful, psychologically, as gains. When defined in terms of the utility function shape as in the Cumulative Prospect Theory (CPT), losses have a steeper utility than gains, thus being more "painful" than the satisfaction from a comparable gain as shown in Figure 1.
Framing (social sciences)In the social sciences, framing comprises a set of concepts and theoretical perspectives on how individuals, groups, and societies organize, perceive, and communicate about reality. Framing can manifest in thought or interpersonal communication. Frames in thought consist of the mental representations, interpretations, and simplifications of reality. Frames in communication consist of the communication of frames between different actors. Framing is a key component of sociology, the study of social interaction among humans.
Framing effect (psychology)The framing effect is a cognitive bias where people decide between options based on whether the options are presented with positive or negative connotations. Individuals have a tendency to make risk-avoidant choices when options are positively framed, while selecting more loss-avoidant options when presented with a negative frame. In studies of the bias, options are presented in terms of the probability of either losses or gains. While differently expressed, the options described are in effect identical.
Sunk costIn economics and business decision-making, a sunk cost (also known as retrospective cost) is a cost that has already been incurred and cannot be recovered. Sunk costs are contrasted with prospective costs, which are future costs that may be avoided if action is taken. In other words, a sunk cost is a sum paid in the past that is no longer relevant to decisions about the future.
Risk aversionIn economics and finance, risk aversion is the tendency of people to prefer outcomes with low uncertainty to those outcomes with high uncertainty, even if the average outcome of the latter is equal to or higher in monetary value than the more certain outcome. Risk aversion explains the inclination to agree to a situation with a more predictable, but possibly lower payoff, rather than another situation with a highly unpredictable, but possibly higher payoff.
Bounded rationalityBounded rationality is the idea that rationality is limited when individuals make decisions, and under these limitations, rational individuals will select a decision that is satisfactory rather than optimal. Limitations include the difficulty of the problem requiring a decision, the cognitive capability of the mind, and the time available to make the decision. Decision-makers, in this view, act as satisficers, seeking a satisfactory solution, with everything that they have at the moment rather than an optimal solution.
