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Slide 01
Behavioral
Economics
- The Science of Irrational Decisions
- How psychology and economics merged to explain why humans consistently make decisions that standard economic theory says they shouldn't — and what to do about it.
- Cognitive BiasNudge TheoryProspect TheoryHeuristicsDecision Science
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Slide 02
Why Humans Are Not Homo Economicus
- The Foundation
- Classical economics assumed people are rational agents who maximize utility with complete information. Behavioral economics — pioneered by Daniel Kahneman and Amos Tversky in the 1970s — demonstrated that real human decisions are systematically influenced by cognitive shortcuts, emotional states, and social context that standard models cannot predict.
- 200+Documented Cognitive Biases
- 3Nobel Prizes in Behavioral Econ
- $1T+Policy Value Estimated
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Slide 03
Two Systems of Thinking
- Kahneman & Tversky
- System 1: Fast
- Automatic, intuitive, effortless. Operates below conscious awareness. Pattern-matching based on experience. Responsible for most of our daily decisions.
- Examples: Driving a familiar route, recognizing a face, gut reactions to risk, snapping to judgment about a stranger.
- System 2: Slow
- Deliberate, analytical, effortful. Requires attention and mental energy. We believe it controls System 1 — Kahneman showed it mostly ratifies System 1's conclusions.
- Examples: Solving 17×24, comparing mortgage options, evaluating arguments, filling out a tax form.
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Slide 04
Prospect Theory
- The Cornerstone
- Kahneman and Tversky's 1979 paper is the most cited in all of economics. It showed that people evaluate outcomes as gains or losses relative to a reference point — and that losses loom about twice as large as equivalent gains.
- Loss Aversion
- Key finding
- The pain of losing $100 is psychologically roughly twice as intense as the pleasure of gaining $100. This asymmetry distorts insurance purchases, investment decisions, negotiation, and even sporting strategy (golfers putt better on birdie putts than on par putts — the threat of going over par hurts more than the prospect of going under attracts).
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Slide 05
The Power of First Numbers
- Anchoring
- Anchoring occurs when an initial piece of information disproportionately influences subsequent judgments. The first number encountered becomes the reference point from which all estimates adjust — and people adjust insufficiently.
- In a classic study, participants who spun a wheel landing on 10 guessed African nations made up 25% of the UN; those whose wheel landed on 65 guessed 45%. The random number — clearly irrelevant — systematically shifted estimates.
- Where Anchoring Appears
- Salary negotiations — first offer anchors the entire range
- Retail pricing — "was $199, now $129" frames value
- Legal sentencing — judges anchor to prosecution's requested sentence
- Real estate — listing price anchors buyer willingness to pay
- Restaurant menus — expensive items make everything else seem reasonable
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Slide 06
The Nudge:
Richard Thaler's Revolution
- Choice Architecture
- Richard Thaler and Cass Sunstein's Nudge (2008) argued that choice architects — anyone who designs decision environments — inevitably influence choices. Since defaults are unavoidable, they should be set to serve people's long-term interests without restricting freedom.
- Default Rules
- Opt-out organ donation increased donation rates by 20–30% in European countries. People accept defaults; changing a default is the most powerful nudge available.
- Save More Tomorrow
- Thaler's SMarT program commits workers to increase savings rates at the next pay raise. Exploits loss aversion — they never feel the money leaving — and inertia.
- Cafeteria Layout
- Placing fruit at eye level and desserts at the back increases healthy food selection by 25% without removing choices. Environment shapes behavior silently.
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Slide 07
The Core Heuristics
- Cognitive Shortcuts
- Availability Heuristic
- We judge the likelihood of events by how easily examples come to mind. After a plane crash in the news, fear of flying spikes — despite flying getting safer every year.
- Representativeness
- We judge probability by similarity to a prototype. "Linda is 31, outspoken, concerned with social justice — is she more likely a bank teller or a feminist bank teller?" Most say feminist bank teller — statistically impossible.
- Affect Heuristic
- How we feel about something shapes how we estimate its risks and benefits. If we like nuclear power, we judge it less risky; if we dislike it, we judge benefits lower. Emotion precedes analysis.
- Simulation Heuristic
- We estimate likelihood by how easily we can mentally simulate an outcome. Near-misses feel more significant than distant misses — driving why bronze medalists are happier than silver medalists.
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Slide 08
The Inertia Problem
- Status Quo Bias
- People prefer the current state of affairs over alternatives, even when changing would benefit them. The status quo is treated as a reference point against which all changes are evaluated as losses.
- Classic Evidence
- 401(k) enrollment: when automatic enrollment added, participation jumped from 49% to 86%
- Insurance: most people keep their current insurer even when alternatives are clearly cheaper
- Utility switching: only 3% of British consumers switched electricity providers despite potential savings
- Cable plans: consumers keep cable channels they never watch rather than cancel
- Why Inertia Persists
- Three forces reinforce status quo bias: loss aversion (change risks losses), regret aversion (fear of regretting an active choice), and cognitive effort (evaluating alternatives requires System 2 work that we avoid).
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Slide 09
Not All Money Is Equal
- Mental Accounting
- Richard Thaler showed that people treat money differently depending on its source, purpose, or form. Rational economics says a dollar is a dollar. Behavioral economics shows that a windfall dollar gets spent differently than an earned dollar.
- Sunk Cost Fallacy
- People continue investing in losing projects because of past investment. Airline passengers eat bad plane food because "they paid for it." Rational agents ignore sunk costs — humans don't.
- House Money Effect
- Casino winnings are spent more freely than earned income — "it's not really my money." Investors take more risk after gains. Mental accounts keep money from being fungible.
- Budget Categories
- People maintain mental budgets for "entertainment," "food," "clothing." A wine budget affects willingness to buy a bottle even if overall wealth is identical across scenarios.
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Slide 10
What Others Do Shapes What We Do
- Social Proof
- Humans are deeply social beings who use others' behavior as information about what is correct. This is the engine behind social norms, viral trends, and peer pressure. When uncertain, we look to others — and this works surprisingly well on average, making it a powerful heuristic.
- The UK's Behavioural Insights Team showed that including "most people in your area pay their taxes on time" in tax demand letters increased on-time payments by 15% compared to standard letters. Social proof outperformed legal threats.
- Hotel towel reuse: "75% of guests reuse their towels" outperforms environmental appeals
- Restaurant menus: "most popular" label increases item orders by 17%
- Vaccination: social norms messaging more effective than fact campaigns
- Energy use: neighbors' comparisons reduce energy consumption more than cost appeals
- Online reviews: first review sets tone for all subsequent reviews
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Slide 11
How You Say It Is What You Say
- Framing Effects
- Logically equivalent information presented differently produces different decisions. This violates the rational model's assumption that preferences should be stable across equivalent descriptions.
- Classic Study
- The Asian Disease Problem
- Kahneman & Tversky (1981): "Save 200 lives" vs. "400 people die." Logically identical outcomes — different decisions. Positive frames promote risk aversion; negative frames promote risk seeking.
- Real World
- Medical Consent
- "90% survival rate" generates far higher surgical consent than "10% mortality rate" — the same statistic framed differently. Surgeons strategically choose which frame to use.
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Slide 12
Slide 12
- "The standard economic assumption that individuals optimize their own self-interest is simply false."— Richard Thaler, Nobel Prize Lecture, 2017
- 2002Kahneman Nobel Prize
- 2013Shiller Nobel Prize
- 2017Thaler Nobel Prize
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Slide 13
Hyperbolic Discounting
- Time and Decisions
- Rational economic theory assumes people discount the future at a constant rate. Real people discount the near future steeply and the distant future flatly — a bias called hyperbolic discounting. This explains why we procrastinate, fail to save, and make New Year's resolutions we don't keep.
- Present Bias
- We prefer $10 today over $11 tomorrow, but prefer $11 in 31 days over $10 in 30 days — despite identical delay and gain. The "present" gets a special, excessive weight that the future doesn't.
- Self-Control Strategies
- Commitment devices exploit our ability to tie our future selves' hands: gym direct debits, Ulysses-style precommitments, deadline-based contracts. We know we'll procrastinate and try to prevent it.
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Slide 14
The Overconfidence Cluster
- Overconfidence
- Planning Fallacy
- Projects almost always take longer and cost more than estimated. Sydney Opera House: estimated AU$7M, cost AU$102M. London Crossrail: overran by years and billions.
- Better-Than-Average
- 93% of drivers rate themselves above-average. 90% of professors consider themselves above-average teachers. In most skills, most people cannot be above average by definition.
- Calibration Failure
- When people say they are 90% confident, they are correct only about 70–75% of the time. The gap between stated confidence and actual accuracy is systematic and large.
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Slide 15
What We Own, We Overvalue
- Endowment Effect
- In a classic experiment, half of participants were given a coffee mug and asked the minimum price to sell it. The other half were asked the maximum price to buy it. Owners demanded roughly twice what buyers would pay — for the same mug, randomly assigned. Ownership creates value.
- Real-World Appearances
- Homeowners ask more than buyers are willing to pay — market friction
- Free trial subscription models: once owned, users resist cancellation
- Negotiators value their concessions more than opponents do
- IKEA effect: products we assemble feel more valuable than identical pre-assembled versions
- IKEA Effect
- Michael Norton, 2012
- People valued their hand-assembled origami cranes as highly as expert origami — and far above what others would pay for the same objects. Labor creates love.
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Slide 16
Markets Are Not Efficient
- Behavioral Finance
- Robert Shiller's work (Nobel 2013) demonstrated that stock price volatility far exceeds what rational models predict. If prices reflected all available information, they shouldn't fluctuate as wildly as they do. Human emotion, narrative, and herd behavior drive markets.
- The efficient market hypothesis assumes prices reflect all information. Behavioral finance shows that systematic mispricings persist because the forces keeping them in place — overconfidence, herding, loss aversion — are robust and widespread.
- Momentum: stocks that rose last year tend to rise next year — information efficiency would prevent this
- January effect: stocks historically outperform in January — tax-loss selling and reinvestment behavior
- Disposition effect: investors sell winners too early, hold losers too long
- IPO underperformance: new public companies underperform long-term despite initial enthusiasm
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Slide 17
Behavioral Insights in Government
- Policy Applications
- UK Nudge Unit
- The Behavioural Insights Team (2010) — first government nudge unit. Saved hundreds of millions in tax compliance alone. Now operates in 30+ countries.
- Pension Defaults
- Auto-enrollment pension reforms in the UK: 10M+ workers automatically enrolled who weren't saving before. Opt-out rate below 10%. Thaler's research directly implemented.
- SNAP Benefits
- Simplifying US food assistance application reduced required steps from 12 to 3. Eligible family enrollment increased 30%. Complexity is a barrier; simplicity is a policy tool.
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Slide 18
We Find What We're Looking For
- Confirmation Bias
- People favor information that confirms existing beliefs and discount disconfirming evidence. This is perhaps the most consequential cognitive bias — it means we update our beliefs far less than Bayesian rationality would require.
- Wason Selection Task
- Given four cards and a rule to test, most people select cards that can confirm the rule — not the one card that could falsify it. We test hypotheses by looking for support, not refutation.
- Motivated Reasoning
- When evaluating the same study, scientists rate it as higher quality if its conclusions match their prior views. Intelligence doesn't reduce confirmation bias — it amplifies it, providing more sophisticated rationalizations.
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Slide 19
The Environment Thinks for You
- Priming and Context
- 1996John Bargh's "elderly priming" study: participants unscrambling words associated with age walked slower to the elevator. Context activates behavioral schemas without awareness.
- 1999North et al.: French wine sold more on days French music played in a supermarket; German wine on days with German music. Customers didn't notice; behavior changed anyway.
- 2006Chen & Risen: students asked to choose between two options, then given the opposite and told they'd chosen it, justified their "choice" — they confabulated reasons for decisions they hadn't made.
- 2011Danziger et al.: Israeli judges granted parole more often after food breaks. Depleted System 2 defaults to "no" — the safe, status-quo answer.
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Slide 20
We Fear the Wrong Things
- Risk Perception
- Risk perception is driven by availability, controllability, dread, and unfamiliarity — not actual probability. Dramatic, vivid, uncontrollable risks are systematically overestimated; mundane, familiar, self-controlled risks are underestimated.
- After 9/11, Americans shifted from flying to driving. The subsequent traffic fatalities — from the inherently more dangerous mode — exceeded the lives lost in the attacks. The availability-driven fear of flying killed more people than the attack.
- Overestimated Risks
- Plane crashes, shark attacks, stranger abductions, terrorism, vaccine side effects, nuclear power accidents.
- Underestimated Risks
- Car accidents, obesity, diabetes, radon gas, sun exposure, alcohol, sedentary lifestyle, driving while tired.
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Slide 21
Humans Punish Unfairness
- Fairness and Reciprocity
- In the Ultimatum Game, one player proposes how to split $10; the other accepts or rejects. Rejection means neither gets anything. Rational players should accept any offer above $0. Instead, offers below $3 are rejected roughly half the time — people pay real money to punish unfairness.
- Dictator Game
- Even when the recipient has no ability to reject, proposers give an average of 20–30% — pure fairness norm, not strategic calculation.
- Wage Fairness
- Workers who discover colleagues earn more for identical work reduce their own effort. The fairness violation affects performance even when the worker is already paid market rate.
- Price Gouging
- Consumers boycott firms that raise prices in emergencies — "fair" pricing trumps supply-and-demand logic. Thaler documented this extensively in housing and scarce goods markets.
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Slide 22
Behavioral Econ in the Wild
- Marketing and Consumer Behavior
- Free shipping threshold — "add $8 more for free shipping" exploits anchoring and loss aversion to increase basket size
- Decoy pricing — a medium option makes large look like value, small look insufficient
- Scarcity messaging — "only 3 left" activates loss aversion and urgency
- Subscription defaults — auto-renewal exploits status quo bias
- Social proof ratings — 4.7 stars from 12,000 reviews shapes perception of unread reviews
- The Compromise Effect
- When three options are presented (small, medium, large), medium sales increase dramatically. People avoid extremes and choose the "safe" middle ground — a systematic pattern exploited in every tiered pricing model.
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Slide 23
Behavioral Medicine
- Health Decisions
- Patients are among the world's most consequential decision-makers — choosing treatments, adhering to regimens, making lifestyle changes. They are subject to all the same biases as anyone else, with higher stakes.
- Medical defaults shape patient outcomes: opt-out organ donation, automatic medication refills, and pre-committed screening appointments all significantly improve health outcomes without any medical intervention — purely by changing choice architecture.
- Medication adherence improved 30% by pill packs that track doses visually
- Commitment contracts (pay deposit, get it back if you meet health goal) triple behavior change
- Social comparison in calorie labeling outperforms simple calorie counts
- Implementation intentions ("I will exercise at 7am on Tuesdays") double follow-through
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Slide 24
Challenges and Criticisms
- The Replication Crisis
- Behavioral economics has faced criticism since 2011, when several landmark findings failed to replicate under rigorous conditions. The priming literature especially — including the elderly walking study — has not held up. The field is undergoing revision, not collapse.
- What Failed
- Several famous priming effects (money priming, elderly walking, power poses) have not replicated reliably. Sample sizes were too small; file drawer effects hid failures.
- What Survived
- Core findings — loss aversion, anchoring, status quo bias, hyperbolic discounting, social proof — have replicated at scale. The foundational claims of behavioral economics remain robust.
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Slide 25
Algorithms That Exploit Bias
- AI and Behavioral Science
- Machine learning systems are trained on human behavior — which means they're trained on human biases. Recommendation engines optimize for engagement, which means exploiting availability bias, outrage, and social proof to maximize time-on-platform.
- The intersection of behavioral economics and AI design is one of the most consequential ethical frontiers of our era. Systems that understand human psychology at scale can nudge billions of people simultaneously — toward better or worse decisions.
- Social media infinite scroll: removes natural stopping points, exploiting present bias
- Variable reward notifications: mimics slot machine psychology for maximum pull
- Algorithmic outrage: emotionally arousing content gets more shares, rewarded by feed rankings
- Price discrimination at millisecond speed: personalized anchors for each user
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Slide 26
Applying Behavioral Insights
- Practical Toolkit
- For Organizations
- Change defaults, simplify choices, make costs and benefits visible at the right time. Use pre-mortems to counteract overconfidence. Diversify teams to reduce groupthink and confirmation bias.
- For Individuals
- Know your System 1. Sleep before major decisions. Seek disconfirming evidence. Automate financial decisions to remove present-bias from savings. Build commitment devices into important goals.
- For Policy
- Libertarian paternalism: preserve choice while designing defaults that serve long-term interests. Measure with randomized controlled trials. Iterate based on real behavior, not model predictions.
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Slide 27
Key Figures in Behavioral Economics
- The Big Picture
- 1955Herbert Simon coins "bounded rationality" — humans optimize satisfactorily, not maximally, given cognitive limits and information costs.
- 1979Kahneman & Tversky publish Prospect Theory — the founding text of behavioral economics. Loss aversion, reference dependence, probability weighting formalized.
- 1985Richard Thaler publishes mental accounting framework — explains why not all dollars are treated equally.
- 2008Thaler & Sunstein publish Nudge — liberatarian paternalism enters policy vocabulary. UK, US, and Australia establish behavioral insight teams.
- 2011Kahneman's Thinking, Fast and Slow brings behavioral economics to 10M+ general readers. Field reaches popular consciousness.
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Slide 28
The Ethics of Nudging
- Ethical Dimension
- If people's choices can be shaped by default settings and framing without their knowledge, who decides which defaults to set? Critics argue that nudging is paternalistic — substituting policymakers' judgments for individuals' own preferences.
- Thaler and Sunstein's answer is "libertarian paternalism": nudges should preserve freedom of choice while directing defaults toward options the chooser herself would endorse on reflection. But critics note that in practice, nudges often serve institutional interests, not individuals'.
- Who decides what the "right" default is?
- Are nudges manipulative when people don't know they're being nudged?
- Do commercial applications of behavioral economics exploit rather than help?
- Can nudges work against each other when multiple actors nudge simultaneously?
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Slide 29
Where the Field Is Going
- Frontier Research
- Heterogeneity
- Average effects mask enormous individual variation. Machine learning is enabling personalized nudges — interventions calibrated to individual bias profiles.
- Long-Run Effects
- Short-term nudge effects often fade. Research is exploring how to make behavioral change durable — habit formation, identity-based interventions, structural change.
- Cross-Cultural
- Loss aversion and social proof appear universal; specific magnitudes vary by culture. WEIRD (Western, Educated, Industrial, Rich, Democratic) sample bias is a major methodological concern.
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Slide 30
Behavioral Economics
Changed Everything
- The Bottom Line
- Humans are not irrational — they are predictably irrational, in ways we can map, model, and design around. Understanding this is the beginning of better decisions, better organizations, and better policy.
- KahnemanThalerNudgeBiasChoice Architecture
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