Lesson 1 Summary

Behavioral economics studies real-world decision-making, often different from ideal behavior in standard economics, which we illustrated with three examples.
The first example showed that investors who receive more frequent updates about investment performance are more likely to make short-sighted decisions, leading to lower returns than those with less frequent updates.
The second example was about smokers in a “hot” state of craving tobacco, who are able to better predict their behavior in a future state of craving than smokers who make the prediction in a “cold” non-craving state.
The third example used cookies given to co-workers as an illustration of the power of social versus market norms, where colleagues are likely to take fewer cookies when they are offered free of charge than when they are offered for 1 cent.
The examples demonstrated three key factors underlying behavioral economics: uncertainty, decision context, and the influence of System 1 (intuitive and automatic) vs. System 2 (reflective and deliberate) thinking.
Neoclassical economics assumes that individuals make optimal decisions by rationally weighing costs and benefits, acting on full information, and seeking to maximize satisfaction, but behavioral economics highlights the limits of this normative view.