Chapter 8 Behavioral Economics Copyright 2018 McGraw-Hill Education.

Chapter 8 Behavioral Economics Copyright 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. The Origin of Behavioral Economics Neoclassical economics Believe our decisions are rational But evidence shows we make systematic errors Behavioral economics Developed to explain these errors

LO1 Copyright 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 8-2 Comparing Economic Theories Neoclassical economics People have stable preferences that arent 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 LO1 Copyright 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 8-3 Comparing Economic Theories Continued Behavioral economics Focusing on the mental process behind

decisions Improving outcomes by improving decision making LO1 Copyright 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 8-4 Combining Economic Theories Viewing behavioral economics and neoclassical economics as complements

Neoclassical economics at the supermarket Behavioral economics at the supermarket Complementary explanations at the supermarket LO1 Copyright 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 8-5 Contrasting Economic Theories

LO1 Copyright 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 8-6 Our Efficient, Error-Prone Brains Heuristics are energy savers Riding a bicycle with steering heuristics Guesstimating ranks with recognition heuristics The implications of hardwired heuristics

LO2 Copyright 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 8-7 Our Efficient, Error-prone Brains Continued Brain modularity System 1 and System 2 Cognitive biases Confirmation bias

Self-Serving bias Overconfidence effect Hindsight bias Availability heuristic Planning fallacy Framing effects LO2 Copyright 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 8-8 Prospect Theory People judge good things and bad things in

relative terms, as gains and losses to their status quo People experience both diminishing marginal utility for gains as well as diminishing marginal disutility for losses People experience loss aversion, in that they feel losses much more intensely than gains LO3 Copyright 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 8-9

Prospect Theory Continued Prospect theory Losses and shrinking packages Framing effects and advertising Anchoring and credit card bills Mental accounting and overpriced warranties The endowment effect and market transactions Status quo bias LO3 Copyright 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

8-10 Global Perspective LO3 Copyright 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 8-11 Myopia and Time Inconsistency Myopia and Time inconsistency

Fighting self-control problems with precommitments Hiding the alarm clock Automatic payroll deductions Salary smoothing Early withdrawal penalties Weight-loss competitions LO4 Copyright 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 8-12 Fairness and Self-Interest Evidence for fairness exists

Giving to charity Obeying the law Fixing prices Purchasing the Fair-Trade products LO5 Copyright 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 8-13 Fairness and Self-Interest Continued Experimental evidence for fairness

The dictator game The ultimatum game The rules How players behave Why the threat of rejection increases cooperation Implications for market efficiency LO5 Copyright 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 8-14 Nudging People Toward

Better Decisions UK established a Behavioral Insight Team Used to study nudging people towards choices that are better for themselves and others Paying taxes Attending adult literacy class Increasing saving Can be viewed as a form of manipulation 8-15 Copyright 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.