Behavioral Economics is a term related to behavioral finance. This term studies the extensive effects of the psychological, rational, emotional, intellectual and cognitive factors on the economic decision-making process of both individual entities and institutions. The two most essential questions that arise while studying behavioral economics are:
- Can the predicted subjective utility be maximized by the individuals?
- Can the assumptions of economists on the maximization of profit or utility be the exact approximations of a real individual’s attitude?
These questions are answered while studying behavioral economics profoundly. This subject explores why individuals and institutions often make irrational decisions that do not comply with the predictions of the economic entrepreneurial models. These models are responsible for integrating and cumulating the insights from microeconomic theories, psychology, and neurology. While integrating these theories, the behavioral models cover a vast gamut of concepts that further help in entrepreneurial studies. Very often, behavioral economics is also considered to an alternative option for neoclassical economics.
A detailed insight on the principles behavioral economics
Behavioral economics unites the basic ideas of the neoclassical economics with the realities that our human psychology poses. This theory first came to inception from the neoclassical economics in the 20th century. It was developed when the neoclassical theories could not aptly explain the various anomalies that the market economies are susceptible to.
Even though behavioral economics came up from the works of several eminent economists, yet one of the most viable principles of the theory was formulated by economist Herbert Simon. According to Herbert’s theory, often, individuals cannot act logically because they possess a ‘bounded rationality’. Their thoughts, actions, and opinions are always constricted by an ‘idea’ of rationality. In simpler words it can be said that human minds are not infinite; they do not have all information that is necessary for solving problems. Again, they also cannot avail all the time in our globe simply for thinking about the decision. Also, if the outcome of a problem affects one directly, humans try to analyze these outcomes objectively. They do this even more while viewing problems from their personal experience that is warped by socio-cultural bias and constraints.
In an attempt to cope up with these realities, individuals apply their thumb rules while making quick and prompt decisions. This might be inherently rational, but the rules and behavior that they finally end up with, might not be as rational. In fact, according to leading behavioral economist Daniel Kahneman, our thumb rules are irrational.
How are the outcomes predicted from behavioral economics?
Unlike conventional economists, the behavioral economists cannot heavily rely on the mathematical models for predicting the outcomes. Instead of this, they collect and cumulate the ‘real’, ‘authentic’ data on the past consumer behavior and conduct several experiments to check how the consumers might behave in these predicted situations. The aim of this data collection method is to eliminate the unexpected outcomes so that the predicted ones come into attention. Even though these predictions are not as accurate as mathematical equations, yet they are moderately true and accurate predictions. Economists have realized that the realistic assumptions about the human nature eventually lead to better and way more precise results.