# Behavioral Economics

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Category: Economics
Slides: 31
Updated: 2026-05-17T20:49:50.137Z
Tags: economics, behavioral

## Summary

The Psychology of Economic Decisions Key sections include: Behavioral Economics; The Rational Actor Problem; Intellectual Origins; Prospect Theory; Heuristics and Biases; More Cognitive Biases; Mental Accounting; Time Inconsistency and Present Bias; Nudge Theory; Government Nudge Units.

## Slide Outline

1. Behavioral Economics
2. The Rational Actor Problem
3. Intellectual Origins
4. Prospect Theory
5. Heuristics and Biases
6. More Cognitive Biases
7. Mental Accounting
8. Time Inconsistency and Present Bias
9. Nudge Theory
10. Government Nudge Units
11. Behavioral Finance
12. The Framing Effect
13. Social Preferences and Fairness
14. Default Effects and Choice Architecture
15. Behavioral Health Economics
16. Behavioral Public Policy: Taxation
17. Behavioral Economics of Pricing
18. System 1 and System 2
19. The Endowment Effect and WTA-WTP Gap
20. Behavioral Economics of Poverty
21. Behavioral Game Theory
22. Behavioral Environmental Economics
23. Nobel Laureates in Behavioral Economics
24. Criticisms and Debates
25. Behavioral Economics in Tech
26. Behavioral Development Economics
27. Neuroeconomics
28. Kahneman and Tversky: The Partnership
29. The Behavioral Economics Toolkit
30. The Future of Behavioral Economics
31. The Predictably Irrational Animal

## Slide Transcript

### Slide 1: Behavioral Economics

- The Psychology of Economic Decisions
- Why humans consistently defy the rational actor model -- and what that means for markets, policy, and everyday life.
- A comprehensive exploration in 31 slides
- 1 / 31

### Slide 2: The Rational Actor Problem

- Classical economics rests on the assumption of Homo economicus -- a perfectly rational agent who maximizes utility with complete information and unlimited cognitive resources. Behavioral economics asks: what if that model is wrong?
- "The agent of economic theory is rational, selfish, and his tastes do not change."
- -- George Stigler and Gary Becker, "De Gustibus Non Est Disputandum," 1977
- Homo Economicus Assumes
- Complete and stable preferences
- Unlimited computational ability
- Perfect self-control and willpower
- Pure self-interest
- Consistent time preferences
- Bayesian updating of beliefs
- Humans Actually
- Preferences shift with framing and context
- Use mental shortcuts (heuristics) that introduce bias
- Procrastinate, overeat, undersave
- Care about fairness, reciprocity, and status
- Discount the future hyperbolically
- Overweight vivid evidence, underweight statistics
- 2 / 31

### Slide 3: Intellectual Origins

- 1738
- Daniel Bernoulli proposes that people evaluate wealth by utility (subjective value) rather than absolute amount -- the first departure from pure expected value theory. His St. Petersburg paradox shows that expected value alone cannot explain gambling behavior.
- 1759
- Adam Smith publishes The Theory of Moral Sentiments, describing loss aversion, overconfidence, and present bias -- 200 years before behavioral economics named them.
- 1955
- Herbert Simon introduces "bounded rationality" -- the idea that humans satisfice rather than optimize, limited by cognitive capacity, time, and information. Nobel Prize 1978.
- 1979
- Daniel Kahneman and Amos Tversky publish "Prospect Theory: An Analysis of Decision under Risk" in Econometrica. The most cited paper in the journal's history. Describes how people actually evaluate gains and losses.
- 2002
- Daniel Kahneman receives the Nobel Prize in Economics -- the first psychologist to do so. Amos Tversky, who died in 1996, would have shared it. The Nobel committee stated it was awarded for "having integrated insights from psychological research into economic science."
- 3 / 31

### Slide 4: Prospect Theory

- Prospect theory is the foundational model of behavioral economics. It replaces expected utility theory's smooth, rational framework with a model that matches how humans actually experience gains and losses.
- Key Features
- Reference dependence: People evaluate outcomes relative to a reference point (usually the status quo), not in absolute terms. A $50,000 salary feels terrible if you expected $60,000 but wonderful if you expected $40,000.
- Loss aversion: Losses loom larger than equivalent gains. Losing $100 hurts about twice as much as gaining $100 feels good. The loss aversion coefficient is approximately 2.0-2.5.
- Diminishing sensitivity: The difference between $100 and $200 feels larger than between $1,100 and $1,200. The value function is concave for gains, convex for losses.
- Probability weighting: People overweight small probabilities (why we buy lottery tickets and insurance) and underweight large ones.
- Implications
- The Endowment Effect
- Once you own something, losing it hurts more than not getting it in the first place. In Kahneman, Knetsch, and Thaler's 1990 mug experiment, owners demanded ~$7.12 to sell; buyers offered ~$2.87. Same mug, same people, 2.5x price gap.
- Status Quo Bias
- People disproportionately stick with the default option. When New Jersey and Pennsylvania offered different default car insurance policies in the 1990s, only 20% of New Jerseyans switched from their limited default, while 75% of Pennsylvanians kept their full-coverage default. Estimated cost difference: $200M/year.
- 4 / 31

### Slide 5: Heuristics and Biases

- "A reliable way to make people believe in falsehoods is frequent repetition, because familiarity is not easily distinguished from truth."
- -- Daniel Kahneman, Thinking, Fast and Slow, 2011
- Anchoring
- Initial exposure to a number biases subsequent estimates. Tversky and Kahneman (1974): spin a rigged wheel showing 10 or 65, then ask "what percentage of African countries are in the UN?" Median answers: 25% (anchor 10) vs. 45% (anchor 65). Real estate agents shown a listing price 12% above market value appraise homes $14,000 higher than those shown a correct price.
- Availability
- We judge probability by how easily examples come to mind. After 9/11, Americans drove instead of flying. The resulting increase in traffic fatalities -- an estimated 1,595 additional road deaths in the 12 months post-9/11 -- exceeded the number killed in the attacks themselves (Gigerenzer, 2004).
- Representativeness
- We judge probabilities by similarity to stereotypes, ignoring base rates. "Linda is 31, single, outspoken, and philosophy-majored." Is she more likely a bank teller or a feminist bank teller? 85% choose feminist bank teller -- a logical impossibility, since the conjunction of two events can't be more probable than either alone.
- 5 / 31

### Slide 6: More Cognitive Biases

- Overconfidence
- People systematically overestimate their knowledge and abilities. In calibration studies, when people say they're "90% confident," they're correct only 70-80% of the time. 93% of American drivers believe they're above-average drivers (Svenson, 1981). CEOs consistently overestimate merger synergies and project returns -- contributing to the ~70% failure rate of M&A deals.
- Sunk Cost Fallacy
- People continue investing in failing projects because they've already spent money, time, or effort. Hal Arkes and Catherine Blumer (1985): people who paid full price for theater tickets attended more boring performances than those given free tickets. The Concorde supersonic jet continued for decades despite being economically unviable -- hence "Concorde fallacy."
- Hindsight Bias
- "I knew it all along." After an event occurs, people believe they predicted it. Fischhoff (1975) showed that knowing an outcome inflates people's estimates of its prior probability by 15-25%. Dangerous in medicine (misdiagnosis reviews), law (jury decisions), and finance (post-crash analysis).
- Confirmation Bias
- People seek and interpret information that confirms their existing beliefs. Peter Wason's (1960) selection task demonstrates this powerfully. In finance, investors seek news confirming their stock picks and ignore contradictory evidence. Political partisans shown identical policy data draw opposite conclusions (Lord, Ross, & Lepper, 1979).
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### Slide 7: Mental Accounting

- Richard Thaler's concept of mental accounting describes how people categorize money into separate psychological "accounts," violating the economic principle that money is fungible (a dollar is a dollar).
- Classic Examples
- The Theater Ticket Problem
- You arrive at the theater and discover you've lost your $10 ticket. Do you buy another? Most people say no. But if you arrive and realize you've lost a $10 bill, most people buy the ticket. Economically identical, psychologically different: the lost ticket is debited to the "entertainment account" (making the show seem to cost $20), while the lost bill comes from a general fund.
- The Jacket/Calculator Problem
- Would you drive 20 minutes to save $5 on a $15 calculator? Most say yes. Would you drive 20 minutes to save $5 on a $125 jacket? Most say no. But $5 is $5 -- the savings are identical. We evaluate discounts proportionally (33% vs. 4%), not in absolute terms.
- Real-World Impact
- Tax Refunds
- Americans receive an average $3,100 tax refund and treat it as a windfall -- spending it differently than regular income. They spend refunds on durables and luxuries despite it being their own over-withheld money. An interest-free loan to the government, yet 75% of filers prefer refunds over accurate withholding.
- Credit Card Effect
- People spend 12-18% more when paying with credit cards than cash (Prelec & Simester, 2001). The "pain of paying" is reduced when payment is decoupled from consumption. This is why casinos use chips and Uber doesn't show the meter running.
- 7 / 31

### Slide 8: Time Inconsistency and Present Bias

- "In the morning, I resolve to eat less at dinner. But by the time dinner arrives, the resolution has vanished."
- -- Adam Smith, The Theory of Moral Sentiments, 1759
- Hyperbolic Discounting
- Standard economics assumes exponential discounting: we discount future rewards at a constant rate. But humans use hyperbolic discounting -- we heavily discount the near future but are relatively patient about the distant future.
- Example: Most people prefer $100 today over $110 tomorrow, but prefer $110 in 31 days over $100 in 30 days. The one-day wait is the same, but proximity to "now" changes the choice. This explains:
- Procrastination (the task feels costless tomorrow)
- Under-saving for retirement (retirement feels distant)
- Diet and exercise failures (the cookie is now, the benefit is later)
- Commitment Devices
- Knowing our future selves will be tempted, we seek ways to bind ourselves:
- Odysseus: Had himself tied to the mast to resist the Sirens
- Christmas Clubs: Illiquid savings accounts paying 0% interest -- $2.5B deposited annually in the U.S. People willingly sacrifice returns for enforced saving
- stickK.com: Founded by Yale economist Dean Karlan. Users commit money that goes to a charity they hate if they fail their goal. $50M+ committed, 78% success rate vs. 29% for unmonitored goals
- 401(k) auto-enrollment: The single most effective savings intervention ever devised
- 8 / 31

### Slide 9: Nudge Theory

- Nudge theory, developed by Richard Thaler and Cass Sunstein in their 2008 book Nudge, proposes using insights from behavioral economics to design "choice architectures" that help people make better decisions without restricting freedom.
- Libertarian Paternalism
- The philosophy is libertarian (preserving choice) and paternalistic (guiding toward better outcomes). A nudge steers behavior without bans, mandates, or significant economic incentives.
- The EAST Framework (BIT)
- Easy: Reduce friction. Default enrollment. Pre-filled forms.
- Attractive: Make the desired option salient. Use color, placement, social proof.
- Social: "9 out of 10 people in your area pay their taxes on time."
- Timely: Intervene at the moment of decision. Tax-time savings prompts.
- Landmark Nudges
- Retirement Savings
- Changing 401(k) enrollment from opt-in to opt-out increased participation from 49% to 86% in one study (Madrian & Shea, 2001). Auto-escalation (increasing contribution rate by 1% per year) raised savings rates from 3.5% to 13.6% over 40 months (Thaler & Benartzi's Save More Tomorrow program, 2004).
- Organ Donation
- Countries with opt-out organ donation have 85-99% donor registration rates vs. 4-28% for opt-in countries. Austria (opt-out): 99.98%. Germany (opt-in): 12%. Johnson & Goldstein (2003). Many U.S. states are adopting opt-out or mandated choice systems.
- 9 / 31

### Slide 10: Government Nudge Units

- UK Behavioural Insights Team (BIT)
- Founded in 2010 by David Cameron's government. The world's first "nudge unit," led by David Halpern. Originally inside 10 Downing Street, now a social purpose company operating in 30+ countries with 200+ staff.
- Key results:
- Adding a single sentence to tax letters ("Most people in your town have already paid") increased payment rates by 15%, collecting an additional $210M in the first year
- Simplifying college enrollment forms for low-income students increased attendance by 8 percentage points
- Text message reminders before court dates reduced failure-to-appear by 26%
- Other Nudge Units
- SBST/OES (U.S.): Obama's Social and Behavioral Sciences Team (2014). Now the Office of Evaluation Sciences at GSA. Ran 100+ randomized trials across federal agencies. Auto-enrolled military members in TSP retirement savings, adding $8B in savings.
- Australia (BETA): Behavioural Economics Team of the Australian Government. Reduced unnecessary antibiotic prescriptions by 12% through peer comparison letters.
- Singapore (CSEU): Civil Service College's Behavioural Insights Unit. Increased CPF (retirement) contributions through defaults.
- World Bank MIND: Behavioural sciences unit working across 40+ developing countries.
- As of 2024, 400+ public institutions worldwide have applied behavioral insights.
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### Slide 11: Behavioral Finance

- If markets are made up of biased humans, markets themselves will exhibit systematic irrationality. Behavioral finance, pioneered by Robert Shiller, applies behavioral economics to asset prices, trading, and bubbles.
- Market Anomalies
- Momentum effect: Stocks that have risen continue to rise; stocks that have fallen continue to fall. Jegadeesh & Titman (1993) showed a momentum strategy earned 12% annualized returns over 3-12 month horizons.
- Disposition effect: Investors sell winners too early and hold losers too long. Odean (1998) showed investors are 50% more likely to sell a winning stock than a losing one -- the opposite of tax-optimal behavior.
- January effect: Small-cap stocks outperform in January (tax-loss selling in December creates buying opportunities).
- Excess volatility: Stock prices fluctuate far more than underlying dividends justify. Shiller (1981) showed S&P 500 volatility was 5-13x dividend volatility.
- Bubbles and Crashes
- Shiller's "Irrational Exuberance" (2000) -- named after Greenspan's 1996 phrase -- warned about the dot-com bubble. His cyclically adjusted price-earnings (CAPE) ratio showed stocks at valuations seen only before the 1929 crash. The Nasdaq fell 78% over the next two years.
- Behavioral explanations for bubbles: herding (following the crowd), overconfidence (this time is different), recency bias (projecting recent returns), narrative economics (Shiller, 2019) -- stories drive economic decisions more than fundamentals.
- Shiller won the Nobel Prize in 2013 for showing that long-term asset prices are somewhat predictable based on valuation ratios -- contradicting the efficient market hypothesis.
- 11 / 31

### Slide 12: The Framing Effect

- "The way a problem is framed can change the answer. This is a deep challenge to the rational model, which says preferences should not depend on description."
- -- Amos Tversky
- The Asian Disease Problem
- Tversky & Kahneman (1981): 600 people will die from a disease. Choose a program.
- Positive frame: A saves 200 lives (certain) vs. B has 1/3 chance of saving 600, 2/3 chance of saving nobody. 72% choose A -- risk-averse.
- Negative frame: C means 400 die (certain) vs. D has 1/3 chance nobody dies, 2/3 chance 600 die. 78% choose D -- risk-seeking.
- A and C are identical. B and D are identical. But framing as "lives saved" (gain) vs. "lives lost" (loss) reverses preferences.
- Real-World Framing
- Meat labeling: "75% lean" vs. "25% fat" -- same product, different perception. Consumers rate 75% lean as healthier and tastier (Levin & Gaeth, 1988).
- Surgery consent: "90% survival rate" vs. "10% mortality rate." Patients are 2x more likely to consent with the survival frame (McNeil et al., 1982).
- Credit card surcharges: The credit card industry spent decades lobbying to label the cash/credit price difference a "cash discount" rather than a "credit card surcharge." Framing as surcharge reduces credit card use by 10%.
- Tax policy: "Death tax" vs. "estate tax" -- Frank Luntz's reframing shifted public opinion by 20+ points.
- 12 / 31

### Slide 13: Social Preferences and Fairness

- Homo economicus cares only about his own payoff. Real humans care deeply about fairness, reciprocity, and relative standing.
- The Ultimatum Game
- Werner Guth (1982): Two players split $10. The Proposer offers a split; the Responder accepts or rejects. If rejected, both get nothing. Rational prediction: Proposer offers $1, Responder accepts (something beats nothing).
- Actual results across 15+ countries: Modal offer is 40-50%. Offers below 20% are rejected 50%+ of the time. People sacrifice money to punish unfairness. Cross-cultural variation: Machiguenga (Peru) offer 26%; Lamalera (Indonesia) offer 58%.
- The Dictator Game
- Same as ultimatum but the Responder cannot reject. Rational prediction: offer $0. Actual: average offer is 25-30%. Some offer 50%. People give money even when they don't have to -- contradicting pure self-interest.
- But context matters: when the dictator earns the money (rather than receiving it as a windfall), offers drop to 10-15%. When anonymity is increased, offers drop further. "People are not purely selfish; they are impurely altruistic."
- Inequality Aversion
- Fehr & Schmidt (1999) model: people dislike both being ahead (guilt) and behind (envy). In lab experiments, 50-60% of people sacrifice personal income to reduce others' excessive earnings. Explains rejection of "unfair" wage offers, support for redistribution, and tipping.
- Reciprocity
- People reward kindness and punish unkindness even at personal cost. Ernst Fehr's "strong reciprocity" experiments: third-party observers pay to punish unfair dictators, even when they themselves are not affected. This "altruistic punishment" may be the foundation of human cooperation and social norms.
- 13 / 31

### Slide 14: Default Effects and Choice Architecture

- Defaults are the most powerful tool in the nudge toolkit. They exploit inertia, loss aversion, and the implicit endorsement of the default-setter.
- 90%Of people stick with default options
- $7.4TU.S. 401(k) assets (aided by auto-enrollment)
- 38%Increase in savings from auto-enrollment
- Why Defaults Work
- Effort: Changing requires active decision-making. The cognitive cost of opting out exceeds the perceived benefit.
- Endorsement: People assume the default is the recommended option. "They must know what's best."
- Loss aversion: Moving away from the default feels like losing something.
- Reference point: The default becomes the status quo, anchoring expectations.
- Dark Patterns
- Defaults can be used against consumer interests. Harry Brignull coined "dark patterns" (2010) -- deceptive UI designs exploiting behavioral biases. Examples:
- Pre-checked boxes for newsletter subscriptions or insurance add-ons
- "Confirm-shaming": "No thanks, I don't want to save money"
- Roach Motel: easy to subscribe, hard to cancel
- The FTC fined Fortnite maker Epic Games $245M in 2022 for dark pattern purchases
- 14 / 31

### Slide 15: Behavioral Health Economics

- Organ Donation
- The default saves lives. Spain's presumed consent (opt-out) system yields 49.6 donors per million population -- the world's highest. The U.S. (opt-in) has 36.1 per million. Wales switched to opt-out in 2015; consent rates rose from 58% to 75%.
- But defaults alone are not sufficient: Spain's success also relies on transplant coordinators in every hospital, rapid response teams, and cultural acceptance. Behavioral + structural interventions together are most effective.
- Medication Adherence
- 50% of patients with chronic conditions don't take medications as prescribed, costing $290 billion/year in the U.S. Behavioral interventions:
- Pillbox with lottery incentive (Volpp, 2011): adherence rose from 36% to 53%
- Active choice at pharmacy pickup: "Your refill is ready. Pick up or defer?" vs. passive waiting
- Social commitment: sharing adherence data with a family member increased rates by 12%
- Simplification: once-daily vs. three-times-daily dosing doubles adherence
- "The best medicine in the world is useless if the patient doesn't take it."
- -- C. Everett Koop, U.S. Surgeon General (1982-1989)
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### Slide 16: Behavioral Public Policy: Taxation

- Tax Compliance
- The IRS tax gap (taxes owed but not paid) was $688 billion in 2021. Behavioral interventions are remarkably effective:
- Social norms messaging: "9 out of 10 people in your area pay on time" increased payment by 15% (UK BIT). Replicated in 20+ countries.
- Simplification: Pre-populated tax returns (used in Denmark, Sweden) reduce errors and increase compliance. California's ReadyReturn pilot showed 99% satisfaction.
- Salience: Making tax bills more visible increases payment. Embedding tax amounts in price tags (vs. adding at checkout) reduces purchases of taxed goods by 8% (Chetty, Looney, & Kroft, 2009).
- Tax Design
- Behavioral insights reveal that the structure of taxes matters as much as the rate:
- Tax salience: Sales taxes are "hidden" at checkout; income taxes are salient on paystubs. The less salient a tax, the less it affects behavior -- and the less political opposition it generates.
- Withholding illusion: People treat tax refunds as bonuses rather than returned overpayments. They spend them on discretionary goods.
- Complexity as deterrent: The earned income tax credit (EITC) is claimed by only 78-80% of eligible families because the form is complex. Simplifying it could transfer $4-7 billion more to low-income households.
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### Slide 17: Behavioral Economics of Pricing

- The Decoy Effect
- Adding an inferior third option changes preferences between the original two. Dan Ariely's classic: The Economist offered online-only ($59), print-only ($125), or print+online ($125). Print-only is dominated -- nobody should choose it. But its presence makes print+online look like a bargain. Without the decoy, 68% chose online-only. With it, 84% chose print+online.
- Used extensively in SaaS pricing tiers, real estate (showing an overpriced property to make another seem reasonable), and restaurant menus (an expensive entree makes the second-most expensive seem moderate).
- Price Anchoring
- Original price slashing: "$200 NOW $99" -- the $200 anchor makes $99 feel cheap even if the item was never sold at $200. The FTC has enforcement actions against fictitious original prices.
- Charm pricing: $9.99 vs. $10.00. MIT/University of Chicago experiment (2003): identical products sold at $34, $39, and $44. The $39 item outsold both -- not because it was cheapest but because .99 pricing triggers a "bargain" heuristic.
- Quantity anchors: "Limit 12 per customer" on soup cans increased purchases from 3.3 to 7.0 cans (Wansink, Kent, & Hoch, 1998). The limit creates an anchor for appropriate quantity.
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### Slide 18: System 1 and System 2

- Kahneman's framework from Thinking, Fast and Slow (2011) divides cognition into two systems -- a powerful metaphor that captures decades of dual-process theory research.
- System 1: Fast Thinking
- Automatic, effortless, always-on
- Handles pattern recognition, emotional reactions, first impressions
- Uses heuristics (mental shortcuts)
- Prone to biases and systematic errors
- Processes 11 million bits of information per second
- "Seeing that a person is angry" = System 1
- Responsible for ~95% of all cognitive activity.
- System 2: Slow Thinking
- Deliberate, effortful, requires attention
- Handles complex calculations, logical reasoning, self-control
- Can override System 1 but is lazy and easily depleted
- Processes ~50 bits per second
- "Computing 17 x 24" = System 2
- Engaged by novelty, conflict, or explicit instruction
- Most behavioral biases occur when System 1 operates unchecked.
- "Laziness is built deep into our nature. Even System 2 will take the path of least effort."
- -- Daniel Kahneman, Thinking, Fast and Slow
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### Slide 19: The Endowment Effect and WTA-WTP Gap

- The Core Phenomenon
- People demand more to give up an object than they would pay to acquire it. This "willingness to accept" (WTA) vs. "willingness to pay" (WTP) gap ranges from 2:1 to 10:1 in experiments, depending on the good.
- Thaler's Market Experiments
- In Kahneman, Knetsch, and Thaler's 1990 experiments at Cornell, students randomly given mugs demanded $5.25 to sell; those without mugs offered $2.25 to buy. Standard theory predicts equal trading -- about half should trade. Actual trading volume: one-quarter of expected. The endowment effect reduces market efficiency.
- When It Disappears
- Professional traders: Experienced market participants show reduced endowment effects. John List (2003) found that sports card dealers exhibit no WTA-WTP gap, while novice collectors do. Markets may train the bias away.
- Goods "held for exchange": Items intended for resale (inventory, tokens representing money) show no endowment effect. It affects goods held for "use" -- things we psychologically incorporate into our identity.
- Policy implications: The endowment effect explains why people resist policy changes that take away existing benefits (even if replaced with objectively better ones) and why initial resource allocations have lasting effects on distribution.
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### Slide 20: Behavioral Economics of Poverty

- "Poverty is not simply a lack of money. It is a condition that imposes cognitive demands that reduce bandwidth for everything else."
- -- Sendhil Mullainathan and Eldar Shafir, Scarcity, 2013
- Scarcity Mindset
- Mullainathan and Shafir showed that scarcity of any resource (money, time, food) creates a "tunneling" effect -- focus on immediate needs crowds out long-term planning. Sugarcane farmers in Tamil Nadu scored 13 IQ points lower before harvest (when poor) vs. after harvest (when flush) -- equivalent to losing a night's sleep or chronic alcoholism. Poverty itself impairs decision-making.
- Implications for Policy
- Simplify aid programs: Complex application processes (Medicaid, food stamps) create barriers that disproportionately affect those with depleted cognitive bandwidth.
- Cash transfers: GiveDirectly's unconditional cash transfers ($1,000 to poor households in Kenya) show recipients make rational investments -- contradicting paternalistic assumptions. $300M distributed to 400,000 people.
- Timing matters: Savings programs timed to harvest or payday (when people feel flush) are more effective than those offered during scarcity.
- Reducing decisions: Automatic benefits enrollment reduces the "decision tax" on the poor.
- 20 / 31

### Slide 21: Behavioral Game Theory

- Classical game theory assumes players are perfectly rational and know others are too. Behavioral game theory studies how real people play strategic games.
- The p-Beauty Contest
- Pick a number 0-100. The winner is closest to 2/3 of the average. Nash equilibrium: 0 (everyone should reason their way down). Actual results: average guess is 35-40. First-time players think 1-2 steps ahead, not infinitely. Level-0 thinkers guess randomly (~50). Level-1 thinkers guess 33 (2/3 of 50). Level-2: 22. Most people are Level-1 or Level-2 thinkers.
- The Trust Game
- Player A sends money to Player B (tripled by experimenter). Player B decides how much to return. Rational prediction: B returns nothing, so A sends nothing. Actual: A sends 50%+ of endowment; B returns ~33%. Trust and reciprocity create value that pure self-interest destroys.
- Oxytocin administration increases trust (Zak, 2005). Testosterone reduces generosity. Culture matters: trust game returns correlate with national trust survey data (r=0.6) and GDP per capita.
- Quantal Response Equilibrium (McKelvey & Palfrey, 1995)
- QRE replaces the assumption that players always best-respond with a probabilistic model: better strategies are played more often, but not exclusively. This single modification explains a vast range of experimental anomalies in games. The model has one parameter -- rationality level -- and fits data remarkably well across hundreds of experiments.
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### Slide 22: Behavioral Environmental Economics

- Energy Conservation
- Opower (now Oracle Utilities) sends home energy reports comparing your usage to neighbors'. Robert Cialdini's social norms research underpins the design. Results across 100+ utilities in 9 countries: average 2% energy reduction -- modest per household but massive at scale ($3 billion in savings, 40 billion kWh saved by 2023). Injunctive norms (smiley/frowny faces) prevent the "boomerang effect" where below-average users increase consumption.
- Carbon Footprint Labels
- Making carbon costs visible changes purchasing. Unilever's carbon labels on products (2019) showed that transparency influenced 13% of consumers to switch to lower-carbon alternatives. Restaurant menus with carbon labels reduced high-emission meal choices by 5-10% in trials at Cambridge, Johns Hopkins, and Stockholm University.
- The Green Default
- Switching electricity contracts to renewable energy by default (with opt-out): Schlotzau, Switzerland achieved 94% green energy adoption (Pichert & Katsikopoulos, 2008). Without the default: ~7%. Germany's 2022 energy law allows municipalities to set green defaults. This single intervention could accelerate renewable adoption faster than subsidies.
- Present Bias and Climate
- Climate change is the ultimate present-bias problem: costs of action are now; benefits are decades away. Solutions: make climate impacts tangible (flood maps, heat projections for your neighborhood), create immediate rewards for green behavior (gamification, social recognition), and use commitment devices (carbon pledges with penalties).
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### Slide 23: Nobel Laureates in Behavioral Economics

- Herbert Simon (1978)
- "For his pioneering research into the decision-making process within economic organizations." Introduced bounded rationality and satisficing. Political scientist by training, he showed that firms don't optimize -- they find "good enough" solutions under constraints. His work spans AI, cognitive science, and organizational theory.
- Daniel Kahneman (2002)
- "For having integrated insights from psychological research into economic science, especially concerning human judgment and decision-making under uncertainty." A psychologist who never took an economics course. His work with Amos Tversky (died 1996) on prospect theory and heuristics and biases created the field. Thinking, Fast and Slow (2011) sold 10 million+ copies.
- Robert Shiller (2013)
- "For empirical analysis of asset prices." Showed that stock and housing markets deviate predictably from fundamental value due to "animal spirits" and narrative-driven behavior. Predicted the dot-com crash (2000) and the housing bubble (2005). His Case-Shiller Home Price Index is the standard measure of U.S. housing prices.
- Richard Thaler (2017)
- "For his contributions to behavioural economics." Pioneered mental accounting, the endowment effect, and nudge theory. His "Save More Tomorrow" program has helped 15 million Americans increase retirement savings. Co-founded Fuller & Thaler Asset Management, which manages $10B+ using behavioral insights. Known for his cameo in The Big Short explaining CDOs.
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### Slide 24: Criticisms and Debates

- The Replication Crisis
- Several foundational behavioral economics findings have failed to replicate:
- Ego depletion: Baumeister's (1998) finding that willpower is a limited resource -- a multi-lab replication (2016, 23 labs) found essentially no effect.
- Priming effects: Many of Kahneman's cited priming studies (Chapter 4 of Thinking, Fast and Slow) have not replicated. Kahneman himself acknowledged this as a "train wreck."
- Power posing: Amy Cuddy's "power pose" study (2010) failed to replicate the testosterone effect (though self-reported confidence effects persist).
- Core findings (prospect theory, anchoring, default effects, social norms) have replicated robustly.
- Theoretical Critiques
- Gerd Gigerenzer: Heuristics are not biases but adaptive tools. "Fast and frugal" heuristics often outperform complex optimization in real-world environments with uncertainty. The "bias-bias" -- labeling every deviation from rationality as an error.
- Ecological rationality: In natural environments (unlike lab experiments), our heuristics work well because they evolved for real-world statistical structures.
- Libertarian paternalism critique: Who decides what's "better"? Nudges presume a benevolent, informed choice architect. But nudgers have their own biases. Glen Whitman and Mario Rizzo argue nudges create a slippery slope toward state control.
- Scale concerns: Many nudge effects are small (1-5%) and may decay over time as novelty fades.
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### Slide 25: Behavioral Economics in Tech

- "The best minds of my generation are thinking about how to make people click ads."
- -- Jeff Hammerbacher, former Facebook data scientist, 2011
- Attention as a Scarce Resource
- Tech companies are the most sophisticated applied behavioral economists in the world. Every app exploits cognitive biases:
- Variable ratio reinforcement: Pull-to-refresh mimics slot machines. Unpredictable rewards (new posts, likes) are the most addictive reinforcement schedule (B.F. Skinner, 1950s)
- Social proof: Like counts, follower numbers, "trending" labels
- Loss aversion: Snapchat streaks -- losing your streak feels like losing something you built
- FOMO: Instagram stories that disappear in 24 hours create urgency
- Sunk cost: Game progress, loyalty points, streak data keep users from switching
- Subscription Economy
- The subscription model is behavioral economics made manifest:
- Free trials + auto-renew: 84% of users forget to cancel (per Zuora). Default is continued subscription (loss aversion + status quo bias + inertia).
- Decoupled payment: Monthly charges reduce pain of paying vs. one-time purchase.
- The FTC's "click to cancel" rule (2024): Requires cancellation to be as easy as sign-up, combating roach motel patterns.
- Amazon Prime's $139/year fee creates a sunk cost that drives users to shop on Amazon to "justify" the membership -- increasing spending by 2-3x vs. non-Prime members.
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### Slide 26: Behavioral Development Economics

- The 2019 Nobel Prize went to Abhijit Banerjee, Esther Duflo, and Michael Kremer for applying experimental methods -- particularly randomized controlled trials (RCTs) -- to development economics, many informed by behavioral insights.
- Key Findings
- Deworming: Free deworming pills increase school attendance more than cash incentives for education. But uptake drops 75% with even a small fee ($0.30). The "zero price effect" in action (Kremer & Miguel, 2004).
- Chlorine dispensers: Placing chlorine dispensers at water collection points (rather than distributing bottles) increased usage from 10% to 61%. Behavioral design: reduce friction, leverage habit formation, add social visibility.
- Microfinance reality: RCTs showed microfinance does not transform lives as promised. Borrowers use loans for consumption smoothing, not entrepreneurship. Mental accounting: "business loan" money leaks into household spending.
- Fertilizer timing: Offering fertilizer at harvest time (when farmers have cash) dramatically increases adoption vs. offering at planting time (when cash is scarce). Present bias makes the commitment at harvest easy.
- J-PAL: The Laboratory
- The Abdul Latif Jameel Poverty Action Lab (J-PAL), co-founded by Banerjee and Duflo at MIT in 2003, has run 1,000+ RCTs in 90+ countries. Policy impact: governments have scaled J-PAL-tested programs reaching 600 million people.
- Signature behavioral insight: small barriers have enormous effects on the poor. A 2-mile walk to a clinic reduces vaccination by 30%. A confusing form reduces benefit claims by 40%. Removing these "last mile" frictions is often more cost-effective than increasing program budgets.
- Duflo, at 46, was the youngest person and second woman to receive the economics Nobel.
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### Slide 27: Neuroeconomics

- Neuroeconomics uses brain imaging, neurological patients, and computational models to understand the biological basis of economic decisions.
- The Neural Basis of Decision-Making
- Ventromedial prefrontal cortex (vmPFC): Encodes value of options. Patients with vmPFC damage (like Phineas Gage) make poor financial decisions despite intact IQ. Antonio Damasio's "somatic marker hypothesis" (1994): emotions are essential, not opposed, to rational choice.
- Striatum (nucleus accumbens): Dopamine signals reward prediction error -- the difference between expected and actual outcomes. This is the neural substrate of reference-dependent utility in prospect theory.
- Amygdala: Processes fear and loss aversion. Patients with bilateral amygdala damage (Urbach-Wiethe disease) show no loss aversion (De Martino et al., 2010).
- Insula: Activated by disgust and unfair offers in the ultimatum game. Predicts rejection of unfair splits.
- Key Experiments
- McClure et al. (2004)
- fMRI during intertemporal choice: immediate rewards activate limbic (emotional) areas; delayed rewards activate prefrontal (rational) areas. The "two systems" of Kahneman mapped onto brain anatomy. But: later studies show this dichotomy is oversimplified -- both systems contribute to both types of choice.
- Knutson et al. (2007)
- Brain activity predicts purchasing decisions before people are consciously aware of their choice. Nucleus accumbens activation predicts buying; insula activation predicts not buying. Product desirability and price are encoded in different brain regions and integrated in the prefrontal cortex.
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### Slide 28: Kahneman and Tversky: The Partnership

- "They were more than the sum of their parts. When they were together, they could finish each other's thoughts. When they were apart, they wrote ordinary papers."
- -- Michael Lewis, The Undoing Project, 2016
- Daniel Kahneman (1934-2024)
- Born in Tel Aviv, raised in Nazi-occupied France. Studied psychology at Hebrew University. His childhood experience of irrationality in human behavior -- surviving by luck, witnessing arbitrary cruelty -- shaped his skepticism of rational models. Won the Nobel in 2002 (the only psychologist in economics). Thinking, Fast and Slow sold 10M+ copies. Died March 27, 2024, at age 90.
- Amos Tversky (1937-1996)
- Born in Haifa, Israel. Decorated paratrooper (Medal of Distinguished Service for bravery). Brilliant, charismatic, and devastating in debate. Colleagues said: "The smarter you are, the more likely you realize Amos is smarter." A mathematical psychologist who could have excelled in any field. Died of metastatic melanoma at 59, six years before the Nobel that would have been shared with him.
- Their collaboration (1969-1996) produced four of the most cited papers in social science history: on heuristics and biases (1974), prospect theory (1979), framing effects (1981), and cumulative prospect theory (1992).
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### Slide 29: The Behavioral Economics Toolkit

- Defaults
- Set the best option as default. Opt-out > opt-in. Auto-enrollment, pre-selected options, green energy defaults.
- Social Norms
- "Most people do X." Descriptive norms (what people actually do) and injunctive norms (what people should do). Most effective when local and specific.
- Commitment Devices
- Help people bind their future selves. Deposit contracts, public pledges, goal-setting with accountability partners.
- Simplification
- Reduce friction and complexity. Pre-filled forms, clear language, fewer options. Every extra step loses 20-50% of participants.
- Timely Prompts
- Intervene at the decision point. Tax-time savings reminders, appointment reminders (reduce no-shows by 26%), post-purchase surveys.
- Feedback
- Show people the consequences of their choices. Energy usage comparisons, spending trackers, health metrics dashboards.
- Incentive Design
- Small, immediate rewards > large, delayed ones. Lottery-based incentives (variable reward) are more motivating per dollar than guaranteed payments.
- Framing
- Present the same information in the most effective way. Gains vs. losses, absolute vs. relative, frequencies vs. percentages.
- Choice Architecture
- The number, order, and presentation of options shapes choices. Fewer options can increase satisfaction (Iyengar's jam study: 24 jams = 3% purchase; 6 jams = 30%).
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### Slide 30: The Future of Behavioral Economics

- AI and Personalized Nudging
- Machine learning can identify individual behavioral patterns and deliver personalized interventions. Smart thermostats learn your schedule; financial apps detect spending anomalies. Ethical concern: hyper-personalized nudges become manipulation. The line between a helpful prompt and an exploitative dark pattern depends on whose interests are served.
- GPT-scale AI can generate persuasive text optimized for individual psychology. Behavioral science + generative AI raises unprecedented questions about autonomy and consent.
- Emerging Frontiers
- Behavioral macroeconomics: How do aggregate biases (herding, overconfidence) cause recessions and bubbles? Akerlof and Shiller's Animal Spirits (2009) bridges micro biases to macro phenomena.
- Behavioral climate policy: Nudges for sustainable consumption, carbon footprint salience, green defaults at industrial scale.
- Algorithmic nudging regulation: EU Digital Services Act and proposed "dark patterns" legislation in 12+ countries.
- Integration with standard theory: The gap between "behavioral" and "standard" economics is narrowing as rational models incorporate psychological realism.
- "Behavioral economics is not a revolution -- it is a broadening. We are making economics more human."
- -- Richard Thaler, Nobel lecture, 2017
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### Slide 31: The Predictably Irrational Animal

- Behavioral economics has demonstrated that human irrationality is not random noise but a systematic, predictable pattern. By understanding our biases, we can design better institutions, policies, and choices -- not by assuming rationality, but by working with the beautifully flawed minds we actually have.
- "The purely economic man is indeed close to being a social moron."
- -- Amartya Sen, 1977
- Behavioral Economics -- A Presentation
- 31 / 31


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