Behavioural Economics – ECC2600
Exam Notes
Lectures 1-2: Behavioural Economics and The Four Areas
Behavioral economics - The combinaton oo psychology and economics to ex plain economic decision-
making
Rationality: preoerences oo peo ple are consistent. Peo ple know what they preoer; and there are no
contradictons in their preoerences.
Three possibilites / variatons within ratonality:
1. Ratonality: Means Best end End*
2. Sub-Ratonality: Means Sub best end
3. Irratonality (selo-dece pton and delusion:: trying to uustoy Means Sub best end
--Ratonality is only about the directon oo the arrow and executng the o ptmal (End*:.
--So, ratonality is actually an empty concept !
4 areas in which peo ple may violate the ratonality princi ple:
1: Weakness of will (e.g. tem ptaton. It is sub-ratonal and irratonal, the rest are not:
2: Heuristics (Habitual Acts that appear to contradict ratonalityybut they could be o ptmal:
3: Perspective (Judge the same oacts, but with a diferent orame. Related to context:
4: Motivation (context where you uudge based on a goal. Extreme tenacity can be irratonal:
Why context maters
- Io the out put is context-oree, it can true: 100% true, 80% true, or 0% true (i.e., oalse:
- Io the out put is context-laden belieo, it can warranted (as o p posed to “true”:: greatly
warranted, somewhat warranted, or highly unwarranted.
Lecture 3 – Ratonality
Ratonal decisions only when two conditons are met:
1. Scarcity – resource are limited / insufcient
2. Fungibility - there is more than one way to use a resource
Ratonality can take the two oorms oo duality theory
It is im portant because too much irratonality can cause disequilibrium
Lecture 4 - Two Senses oo Ratonality: ecision and Command
ecision sense is identoying the best o pton, the command sense amounts to staving of
procrastnaton, tem ptatons, com pulsionsyi.e., actually executng the ratonal decision.
For agents to make decisions, they must frst have consistent rank-order oo bundles.
Axiom 1: logical ordering (“transitvity axiom”:
Axiom 2: decisiveness (“com pleteness axiom”:
(axiom 6, local non sataton is about how small diferences make a diference:
, Weak Axiom oo Revealed Preoerence (WARP: – io person (weakly: chooses x over y, they (weakly:
preoer it. However, The command sense may be altered orom the original decision due to weakness
oo will or a change in context. Thus this subuect does not subscribe to WARP.
Lecture 5 - Ratonality and its Three Layers
Note: We do not have three “kinds” oo ratonality. Rather, we have the same kind, but it has three
layers or oorms.
1. Cost/Beneft oo Search Best Inoormaton
2. Inoormaton Best Belieo
3. Resources + Belieos Best Acton
These 3 layers determine the decision, which is always o ptmal. Additonally, at each layer the
command can confrm the decision, and hence the commanded choice is o ptmal. Second, the
command can contradict the decision, and hence the commanded choice is sub-o ptmal.
Weakness oo will and selo-dece pton:
- The decision maker succumbs to weakness oo will
- Then, the decision maker denies that he or she succumbed to
Three layers oo selo-dece pton (when the arrows oo the three layers go in the o p posite directon::
1. Red herring - when the agent lets his subo ptmal acton mani pulate his belieo.
(e.g. sour gra pes, sweet lemon:
2. Self-rationalization - the agent lets his subo ptmal belieo mani pulate the inoormaton
(e.g. Adam and Eve holding the subo ptmal belieo that its fne to eat orom tree oo knowledge:
3. Denial - when the agent allows his subo ptmal inoormaton to mani pulate the cost/beneft oo
his search
(e.g. No more ounding oor climate change studies:
Lecture 6 - Probability Judgment and Hindsight Bias
Probability uudgment can be s pilt into (1: accuracy uudgment (2: heuristcs
Exam ple: In a snow storm, is it saoer to take the train or the plane?
This de pends on your belieo: What is your probability uudgment oo likelihood oo accidents in planes as
o p posed to trains in such weather conditons?
Accuracy uudgment is product oo “confdence.” When over-confdence and under-confdence are
involved, then the uudgment is “non-ratonal.”
Over-confdence is an excessive belieo about the ounctonality oo the environment or machines:
-- Exam ples: “there will be no earthquakes in this area oor next 10 years”; “there will be no green-
house efects”; “there will be no plane crashes in the outure.”
Accuracy oo probability uudgement
Peo ple tend to overestmate low- probability events (small pox vaccinaton death and leter x:, while
underestmate high- probability events (heart disease and leter e:
Exam Notes
Lectures 1-2: Behavioural Economics and The Four Areas
Behavioral economics - The combinaton oo psychology and economics to ex plain economic decision-
making
Rationality: preoerences oo peo ple are consistent. Peo ple know what they preoer; and there are no
contradictons in their preoerences.
Three possibilites / variatons within ratonality:
1. Ratonality: Means Best end End*
2. Sub-Ratonality: Means Sub best end
3. Irratonality (selo-dece pton and delusion:: trying to uustoy Means Sub best end
--Ratonality is only about the directon oo the arrow and executng the o ptmal (End*:.
--So, ratonality is actually an empty concept !
4 areas in which peo ple may violate the ratonality princi ple:
1: Weakness of will (e.g. tem ptaton. It is sub-ratonal and irratonal, the rest are not:
2: Heuristics (Habitual Acts that appear to contradict ratonalityybut they could be o ptmal:
3: Perspective (Judge the same oacts, but with a diferent orame. Related to context:
4: Motivation (context where you uudge based on a goal. Extreme tenacity can be irratonal:
Why context maters
- Io the out put is context-oree, it can true: 100% true, 80% true, or 0% true (i.e., oalse:
- Io the out put is context-laden belieo, it can warranted (as o p posed to “true”:: greatly
warranted, somewhat warranted, or highly unwarranted.
Lecture 3 – Ratonality
Ratonal decisions only when two conditons are met:
1. Scarcity – resource are limited / insufcient
2. Fungibility - there is more than one way to use a resource
Ratonality can take the two oorms oo duality theory
It is im portant because too much irratonality can cause disequilibrium
Lecture 4 - Two Senses oo Ratonality: ecision and Command
ecision sense is identoying the best o pton, the command sense amounts to staving of
procrastnaton, tem ptatons, com pulsionsyi.e., actually executng the ratonal decision.
For agents to make decisions, they must frst have consistent rank-order oo bundles.
Axiom 1: logical ordering (“transitvity axiom”:
Axiom 2: decisiveness (“com pleteness axiom”:
(axiom 6, local non sataton is about how small diferences make a diference:
, Weak Axiom oo Revealed Preoerence (WARP: – io person (weakly: chooses x over y, they (weakly:
preoer it. However, The command sense may be altered orom the original decision due to weakness
oo will or a change in context. Thus this subuect does not subscribe to WARP.
Lecture 5 - Ratonality and its Three Layers
Note: We do not have three “kinds” oo ratonality. Rather, we have the same kind, but it has three
layers or oorms.
1. Cost/Beneft oo Search Best Inoormaton
2. Inoormaton Best Belieo
3. Resources + Belieos Best Acton
These 3 layers determine the decision, which is always o ptmal. Additonally, at each layer the
command can confrm the decision, and hence the commanded choice is o ptmal. Second, the
command can contradict the decision, and hence the commanded choice is sub-o ptmal.
Weakness oo will and selo-dece pton:
- The decision maker succumbs to weakness oo will
- Then, the decision maker denies that he or she succumbed to
Three layers oo selo-dece pton (when the arrows oo the three layers go in the o p posite directon::
1. Red herring - when the agent lets his subo ptmal acton mani pulate his belieo.
(e.g. sour gra pes, sweet lemon:
2. Self-rationalization - the agent lets his subo ptmal belieo mani pulate the inoormaton
(e.g. Adam and Eve holding the subo ptmal belieo that its fne to eat orom tree oo knowledge:
3. Denial - when the agent allows his subo ptmal inoormaton to mani pulate the cost/beneft oo
his search
(e.g. No more ounding oor climate change studies:
Lecture 6 - Probability Judgment and Hindsight Bias
Probability uudgment can be s pilt into (1: accuracy uudgment (2: heuristcs
Exam ple: In a snow storm, is it saoer to take the train or the plane?
This de pends on your belieo: What is your probability uudgment oo likelihood oo accidents in planes as
o p posed to trains in such weather conditons?
Accuracy uudgment is product oo “confdence.” When over-confdence and under-confdence are
involved, then the uudgment is “non-ratonal.”
Over-confdence is an excessive belieo about the ounctonality oo the environment or machines:
-- Exam ples: “there will be no earthquakes in this area oor next 10 years”; “there will be no green-
house efects”; “there will be no plane crashes in the outure.”
Accuracy oo probability uudgement
Peo ple tend to overestmate low- probability events (small pox vaccinaton death and leter x:, while
underestmate high- probability events (heart disease and leter e:
