Question

Define behavioral economics. What are three common mistakes that behavioral economics says consumers often make? Give 2 examples of each mistake.

Answer 1

Behavioral economics is the study of situations in which people act in ways that are not economically rational.

Consumers commonly commit the following three mistakes when making decisions:

i)They take into account monetary costs but ignore non-monetary opportunity costs

ii)They fail to ignore sunk costs

iii) They are overly optimistic about future behavior

- Ignoring Nonmonetary Opportunity Costs

Ex: When someone decides to go to college they consider the monetary cost associated with it, the huge cost. But they ignore the non-monetary opportunity cost. In this case, the opportunity cost is the salary that he/she is giving up by going to a college.

- ignore sunk costs

Ex:This may have happened to many of us. This is when we buy a ticket to watch a movie, but as we are planning we are invited at some other place maybe a small party. We generally skip the party because we consider the amount we have paid for the movie tickets. The movie ticket in this example is the sunk cost. The decision should be made while ignoring the sunk costs.

- overly optimistic about future behavior

Ex:An overweight person is eating more in the present because he/she is overly optimistic that he/she will eat less in the future. This tendency leads them to put on more weight. This is a mistake by the consumer when they are too optimistic about their future and do not rationally assess their present actions.