1: What is Behavioral Economics?

What is Behavioral Economics?

Behavioral economics fundamentally challenges the core assumptions of traditional neoclassical economics. While neoclassical models assume individuals are perfectly rational Homo economicus – possessing stable preferences, unlimited cognitive resources, flawless self-control, and purely self-interested motives – behavioral economics argues this is an unrealistic depiction of actual human decision-making. Instead, it integrates robust empirical findings from psychology and cognitive science to build more accurate models of how people actually think, decide, and behave in economic contexts.

The field emerged from the recognition that people systematically and predictably deviate from the idealized rational actor model. These deviations aren't random errors but stem from inherent cognitive limitations (bounded rationality), reliance on mental shortcuts (heuristics), pervasive cognitive biases, emotional influences, social preferences (like fairness or altruism), and difficulties with self-control. For example, individuals might consistently overvalue immediate rewards over larger future ones (time inconsistency), be overly influenced by how choices are presented (framing effects), or make different decisions based on irrelevant starting points (anchoring).

The core mission of behavioral economics is not to discard rational models entirely, but to augment and refine them by incorporating these psychologically realistic elements. It asks: How do people actually process information, evaluate risks and rewards, and make choices under uncertainty and constraints? By answering these questions, behavioral economists aim to develop theories with superior explanatory and predictive power for real-world phenomena – from savings habits and investment choices to market anomalies and consumer behavior.

This interdisciplinary approach bridges economics and psychology. Pioneering work by figures like Daniel Kahneman, Amos Tversky, and Herbert Simon demonstrated that cognitive constraints lead to systematic patterns of judgment and choice errors. Richard Thaler further developed these ideas, applying them to market behaviors and policy design. The ultimate goal is to create a more nuanced, evidence-based understanding of economic activity, leading not only to better academic models but also to more effective policies, products, and interventions that account for actual human psychology.