Behavioural Economics: Core Cognitive Theories and Impact on Economic Decision-Making

Managerial economics
1

Table of Contents
Introduction......................................................................................................................................3
Behavioural economics....................................................................................................................3
Prospect Theory..........................................................................................................................4
Bounded Rationality....................................................................................................................5
Nudge Theory..............................................................................................................................6
Mental Accounting......................................................................................................................7
Search Heuristics.........................................................................................................................7
Conclusion ......................................................................................................................................8
References........................................................................................................................................9
2

Introduction
Economics is a subject which deals with various attributes related to the allocation of the
resources in the society. It also takes into account production, distribution and consumption of
goods and services manufactured with the help of those resources. Economics is a practice and
with time, it keeps on evolving (Wilkinson and Klaes, 2017). Various new theories come up
which further gets practiced as stream of the subject. One such type of economic study is
behavioural economics. It combines the practices of economics with psychology of individuals
and institutions to assess their decision-making process. It is related to normative economics
which reflects ideological or normative judgement towards economic development. It is a recent
concept and was developed in 20th century and has been constantly improved since then to
evolve to present day. This report is aimed at exploring core cognitive theories of behavioural
economics and how they impact economic decision-making.
Behavioural economics
Behavioural economics is one of the recent fields of economics and predominantly deals
with cognitive behaviour of an individual or institution (Dhami, 2016). In other words, it can also
be said to be a study of psychology in the relation of the economics and economic decision-
making. It can be taken into account in respect of both micro-economical and macro-economical
perspective. This theory is opposed to rational choice theory which assumes that people are
rational and while making decisions, they would choose such option that would provide them
maximum satisfaction. Rather, behavioural economics focusses on psychology behind human
behaviour and economics behind how people takes irrational decisions sometimes and how it is
nature of human being to to not follow the path or prediction of economic models (Barberis,
2018). For example, there are two choices of ice-cream in front of a person – chocolate and
vanilla. That person chooses vanilla and behavioural economics focuses on why that person has
gone for vanilla in place of chocolate. Another elaborate example could be - an individual is out
to buy a smartphone. First thing to be decided for the individual would be to decide about the
brand or the specifications such as price, processor, storage capacity, screen size, camera quality,
etc. that one would be seeking the product that would be purchased. For that the person decided
to visit stores to get information and place an order. Now the problem arises that all the brands
showed the variety of products available but all of them had the same basic technology. The
3