Behavioral economics is primarily concerned with the bounds of rationality of economic agents. Framing: The collection of anecdotes and stereotypes that make up the mental sturm sunde bitcoin value individuals rely on to understand and respond to events.
Market inefficiencies: These include mis-pricing and non-rational decision making. In 2002, psychologist Daniel Kahneman was awarded the Nobel Memorial Prize in Economic Sciences “for having integrated insights from psychological research into economic science, especially concerning human judgment and decision-making under uncertainty”. During the classical period of economics, microeconomics was closely linked to psychology. However, many important neo-classical economists incorporated psychological explanations, including Francis Edgeworth, Vilfredo Pareto and Irving Fisher. Bounded rationality is the idea that when individuals make decisions, their rationality is limited by the tractability of the decision problem, their cognitive limitations and the time available. Decision-makers in this view act as satisficers, seeking a satisfactory solution rather than an optimal one.
Bounded rationality implicates the idea that humans take shortcuts that may lead to suboptimal decision-making. Behavioral economists engage in mapping the decision shortcuts that agents use in order to help increase the effectiveness of human decision-making. In 1979, Kahneman and Tversky published Prospect Theory: An Analysis of Decision Under Risk, that used cognitive psychology to explain various divergences of economic decision making from neo-classical theory. Prospect theory has two stages: an editing stage and an evaluation stage.
In the editing stage, risky situations are simplified using various heuristics. Reference dependence: When evaluating outcomes, the decision maker considers a “reference level”. Outcomes are then compared to the reference point and classified as “gains” if greater than the reference point and “losses” if less than the reference point. Loss aversion: Losses are avoided more than equivalent gains are sought. In their 1992 paper, Kahneman and Tversky found the median coefficient of loss aversion to be about 2. 25 times more than equivalent gains reward. Non-linear probability weighting: Decision makers overweight small probabilities and underweight large probabilities—this gives rise to the inverse-S shaped “probability weighting function”.