Introduction to Behavioral Economics

Behavioral Economics challenges traditional economics, integrating psychological insights. It examines how emotional, cognitive, and social factors influence economic decisions, often leading to irrational behaviors that defy classic economic models.

Developed by Kahneman and Tversky, Prospect Theory is pivotal in Behavioral Economics. It suggests people value gains and losses differently, leading to decision-making asymmetries. Losses typically have a greater emotional impact than an equivalent amount of gains.

Heuristics simplify decision-making but can lead to biases. Examples include 'availability', where recent events influence decisions, or 'anchoring', where initial information disproportionately affects perceptions and subsequent judgments.

Nudge theory, by Thaler and Sunstein, proposes subtle policy adjustments to 'nudge' individuals toward beneficial behaviors without restricting freedom of choice. Examples include changing default options to improve pension savings or organ donation rates.

Behavioral Economics reveals time inconsistency, where people's preferences change over time, especially concerning choices between immediate and future benefits. This explains procrastination and challenges in savings or dieting, as immediate gratification often trumps long-term plans.

Emotions can cause market anomalies. For instance, the 'disposition effect' shows investors holding losing stocks too long and selling winners too early, driven by the aversion to realize losses and the desire to lock in gains.

Behavioral Game Theory extends traditional game theory by including how real people behave in strategic situations, often deviating from 'rational' responses. Experiments like the Ultimatum Game illustrate that fairness and spite influence decisions, not just profit maximization.