Behavioral Economics chapter 8

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Behavioral economics
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ttempts to make better predictions about human choice behavior by combining insights from economics, psychology and biology.
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Economic Decisions
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are Rational meaning they maximize our chances of achieving what we want.
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Neoclassical Economic Assumptions provide a precise predictions about human behavior
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• People have stable preferences that aren’t affected by context. • People are eager and accurate calculating machines. • People are good planners who possess plenty of willpower. • People are almost entirely selfish and self interested.
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Neoclassical Economics
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philosophy is Incentives Matter on Price and Drive the Supply and Demand.
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Behavioral Economics
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has various behavioral drives
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Impulse Buying
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consumers buy what they see rather than being driven by incentive pricing
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Heuristics
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low energy mental shortcuts, it is superior to a perfect but costly alternative. are energy savers
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Gaze Heuristic
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brain naturally directs us to see an event
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Shadow Heuristic
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interpreting depth. â–ª These are hard wired to the brain and impossible to unlearn or avoid.
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Brain Modularity
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Specific areas deal with specific sensations, activities, and emotions e.g. vision, breathing and anger.
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System One
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a gut decisions from the older parts of your brainto produce quick reactions.
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System Two
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undertake slow, deliberate and conscious calculations of costs and benefits.
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Cognitive Biases
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the misperceptions or misunderstandings that cause systematic errors.
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Confirmation Bias
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refers to the human tendency to pay attention only to information that agrees with one’s preconceptions.
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Self Serving Bias
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refers to people’s tendency to attribute their successes to personal effort or personal character traits while at the same time attributing any failures to factors that were out of their control.
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Overconfidence Effect
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refers to people’s tendency to be overly confident about how likely their judgments and opinions are to be correct.
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Hindsight Bias
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refers to the ability of people to look back at a situation and know that they picked the right outcome, even though they did not.
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Availability Heuristics
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causes people to base their estimates about the likelihood of an event not on objective facts but on whether or not similar events come to mind quickly and are readily available in their memories.
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Planning Fallacy
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the tendency people have to massively underestimate the time needed to complete a task.
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Framing Effects
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occur when a change in context (frame) causes people to react differently to a particular piece of information or to an otherwise identical situation.
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Three manners we deal with good and bad or Prospect Theory
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o People judge good things and bad in relative terms as gains and losses relative to their status quo. o People experience both diminishing marginal utility for gains as well as for losses. o People experience loss aversion- for losses and gains near the status quo, losses are felt much more intensely than gains. â–ª People see life in terms of gains and losses relative to the status quo, businesses have to be very careful about increasing prices because once consumers become used to a given price they will view any increase in the price as a loss relative to the status quo price they are accustomed.
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The Prospect Theory
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takes into account the fact people’s preferences can change drastically depending on whether contextual information causes them to define a situation as a gain or loss
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ANCHORING
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consumer can make a decision upon irrelevant information to anchor valuations.
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Mental Accounting
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people arbitrarily put certain options into totally separate mental accounts that they dealt with without any thought to options outside of those accounts.
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Endowment Effect
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the tendency that people have to put a higher valuation on anything that they currently possess than on identical items that they do not own but might purchase.
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Status Quo Bias
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the tendency that people have to favor any option that is presented to them as being the status quo option. NOTHING CHANGES BIAS
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Myopia Effect
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the inability to conceptualize the future, compared with the future.
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Time Inconsistency
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is the tendency to systematically misjudge at the present time what you will want to do at some future time.
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Self Control Problems
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It is driven by time inconsistency which makes it difficult to have self control since you do not know the outcome in the future.
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Pre commitments
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are made ahead of time to prevent your future self from doing damage. e.g. Automatic Payroll Deductions to eliminates tax payment problems.
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Fairness and Self Interest
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people are not always Self Centered or driven on Self Interest. People are driven by charity, fairness and love of others.

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