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Behavioral economics provides a realistic and informed perspective on how individuals make economic decisions. It studies the effects of psychological, cognitive, emotional, cultural, and social factors that explain why an individual decides to go with one item instead of another. Through the analysis of Extrapolation Bias, Bounded Rationality, and Saliency Bias Behavioral Economics is illuminated through positive and negative outcomes.
Many people fall for Extrapolation Bias, expecting outcomes in random events to show systematic changes. These individuals believe that a certain random event is more or less likely, given the previous events that took place.
For example, you flip a coin on heads nine times in a row. On that tenth flip the person will assume that the net flip will be tails. However, the odds for each and every flip are calculated separately from one another. The chances will always be the same no matter how many times heads comes up. This can cause the individuals perception to become clouded and lead to ill-advised decisions and investment choices.
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Another idea that deals with decision making from random events is the “hot-hand” fallacy.
This is the belief that a person who experiences success with a random event has a greater probability of future success in additional attempts, for example, in baseball when a player has hit nine homeruns in a row, they believe that his next attempt will be a homerun as well because they have the “hot bat”, or “hot-hand.” Decisions that are made solely based upon recent information instead of all the available data can lead individuals and investors to think current trends are the best predictors of what will happen next in the market.
Even though there is plenty of evidence showing that the “hot-hand” does not exist, tons of people continue to be influenced by the Extrapolation Bias. Studies show that people who gamble on basketball believe strongly in the “hot-hand” fallacy even though its proven to be an incorrect way of decision making. Furthermore, the Extrapolation bias shows that individuals will make quick, irrational decisions based on previous random events that they believe will lead to positive outcomes.
Another example of an Economic Behavior is Bounded Rationality. This is the idea that we make decisions that are rational, but within the limits of the information and time given, as well as the individuals mental capacity. Even when individuals are given a choice and are aware of the alternatives, they still rarely manage to maximize their decisions because people don’t take the time to look at all the information and consider all the options. These individuals will usually choose the option that satisfies their immediate needs and wants without having to put much effort into analyzing the information and weighing out all the options. Many people fall back on using heuristics or “rule of thumb”, to help them come to quicker decision. For example, when choosing from a wide variety of food items at a super-market an individual makes rational decisions of what to buy based on the information he is given, and the time given to make that choice. The end result is we end up making quick decisions rather than informed and well-thought-out ones. Bounded Rationality is a major part of Behavioral Economics and the making of every day decisions by an individual.
There are many optimal strategies that can be used to make a well-informed, rational decision. But, there are also ideas and ways of thinking that can hinder or negatively impact a decision. Saliency Bias is one of these theories and it is the tendency to use available traits to make a judgment about a person or situation. This usually leads to a less-than-optimal outcome and fails to reach its full utility. Individuals tend to focus on the obvious aspects of a situation and ignore the less obvious ones. For example, when taking a shower, you focus on how good the warm water feels and you forget about other important factors like the cost of water, or your goals to conserve water. This theory causes people’s attention to shift away from an important detail to an irrelevant one in the hopes to push the individual towards a certain behavior. In other words, Saliency Bias concludes that individuals will focus on information that is more noticeable and ignore or look over information that may appear less important.
In conclusion, Behavioral Economics provides a realistic and informed prospective on how individuals make economic decisions. Extrapolation Bias, Bounded Rationality, and Saliency Bias are all examples of decision making that influences Behavioral Economics and explains why a person chooses item one instead of item two. Through this analysis of Behavioral Economics, the decisions that are made by an individual are illuminated through their positive and negative outcomes.
Accuracy of Behavioral Economics. (2022, Jun 04). Retrieved from https://studymoose.com/accuracy-of-behavioral-economics-essay
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