Complete and concise notes for the entire course in Behavioural Economics at UCL. Helpful for economics students as well as students choosing to undertake this introductory course as an optional module. Includes the summaries of all assigned reading during the year - for topics like decision-making...
Topic 1: An Introduction to Behavioural Economics
Kahneman, Daniel. "Maps of bounded rationality: Psychology for
behavioural economics."
An attempt to obtain a map of bounded rationality
o Exploring the systematic biases that separate the beliefs that people have and the
choices they make from the optimal beliefs and choices assumed in the rational
agent model
Research on:
Exploring the heuristics that people use and biases they are prone to
in various tasks of judgement under uncertainty, including
predictions and evaluations of evidence
Prospect theory: a model of choice under risk and with loss aversion
in riskless choice
Framing effects and their implications for rational-agent models
Essay offers a unified treatment of intuitive judgment and choice with the
following guiding ideas:
most judgments and most choices are made intuitively
and that the rules that govern intuition are generally similar to the
rules of perception.
Accordingly, the discussion of the rules of intuitive judgments and
choices will rely extensively on visual analogies
o The architecture of cognition: two systems
Two modes of thinking and deciding
Reasoning: done deliberately and effortfully e.g. mental maths
, Intuition: intuitive thoughts seem to come spontaneously to mind
without conscious search or computation
Most thoughts and actions are intuitive though some monitoring of the
quality of mental operations and overt behaviour occurs
However this is normally lax and allows many intuitive judgements
to be expressed including some that are erroneous
Intuitive thinking can be powerful and accurate where high skill is acquired
by prolonged practice and the performance of skills is rapid and effortless
they are also governed by habit, and are therefore difficult to
control or modify
Because the overall capacity for mental effort is limited, effortful processes
tend to disrupt each other, whereas effortless processes neither cause nor
suffer much interference when combined with other tasks
Self-monitoring function belongs with the effortful operations of
system 2 (reasoning)
People who are occupied by a demanding mental activity are much
more likely to respond to another task by blurting out whatever
comes to mind
The perceptual system and the intuitive operations of system 1 generate
impressions of the attributes of objects of perception and thought
These impressions are not voluntary and need not be verbally
explicit.
In contrast, judgments are always explicit and intentional, whether
or not they are overtly expressed.
Thus, System 2 is involved in all judgments, whether they originate
in impressions or in deliberate reasoning.
The label "intuitive" is applied to judgments that directly reflect
impressions.
Perception vs system 1 (intuition)
intuitive judgments occupy a position between the automatic
operations of perception and the deliberate operations of
reasoning.
All the characteristics that students of intuition have attributed to
System 1 are also properties of perceptual operations.
Unlike perception, however, the operations of System 1 are not
restricted to the processing of current stimulation.
Like System 2, the operations of System 1 deal with stored concepts
as well as with percepts, and can be evoked by language
o The accessibility dimension
Accessibility: the ease with which mental contents come to mind
Some relational properties are accessible e.g. if one object is larger
than an object next to it
Statistical properties: When a set of objects of the same general kind
is presented to an observer – whether simultaneously or
successively – a representation of the set is computed automatically,
which includes quite precise information about the average
, Natural assessments: attributes that are routinely and automatically
produced by the perceptual system or system 1 without intention or effort
Impressions that are highly accessible e.g. the height of an option
In addition to physical properties such as size, distance, and
loudness, the list includes more abstract properties such as
similarity, causal propensity, surprisingness, affective valence, and
mood.
The evaluation of stimuli as good or bad
Accessibility is a continuum, not a dichotomy, and some effortful operations
demand more effort than others.
Some of the determinants of accessibility are probably genetic;
others develop through experience.
The acquisition of skill gradually increases the accessibility of useful
responses and of productive ways to organize information, until
skilled performance becomes almost effortless.
This effect of practice is not limited to motor skills
Physical salience also determines accessibility: if a large green letter and a
small blue letter are shown at the same time, "green" will come to mind
first.
However, salience can be overcome by deliberate attention: an
instruction to look for the small object will enhance the accessibility
of all its features.
Accessibility also reflects temporary states of associative activation.
For example, the mention of a familiar social category temporarily
increases the accessibility of the traits associated with the category
stereotype, as indicated by a lowered threshold for recognizing
behaviours as indications of these traits
motivationally relevant and emotionally arousing stimuli spontaneously
attract attention
Billboards are useful to advertisers because paying attention to an
object makes all its features accessible
including those that are not linked to its primary motivational or
emotional significance.
The "hot" states of high emotional and motivational arousal greatly
increase the accessibility of thoughts that relate to the immediate
emotion and to the current needs, and reduce the accessibility of
other thoughts
Ambiguity and uncertainty are suppressed in intuitive judgment as well as in
perception. Doubt is a phenomenon of System 2, an awareness of one's
ability to think incompatible thoughts about the same thing.
o Changes or states: Prospect theory
A general property of perceptual systems is that they are designed to
enhance the accessibility of changes and differences.
Perception is reference-dependent: the perceived attributes of a focal
stimulus reflect the contrast between that stimulus and a context of prior
and con-current stimuli.
E.g. how warm or cold water feels depends on prior stimulation
, In standard economic models, the utility of decision outcomes is assumed to
be determined entirely by the final state of endowment – reference-
independent
Links back to Bernoulli who assumed that states of wealth have a
specified utility and proposed that the decision rule for choice under
risk is to maximise the expected utility of wealth
In reality an abrupt switch from risk aversion to risk seeking is
observed which can’t be plausibly explained by a utility function for
wealth
Preferences appear to be determined by attitudes to gains and losses
defined relative to a reference point
Changes rather than states of wealth
Value function
Concave in the domain of gains favouring risk aversion
Convex in the domain of losses favouring risk seeking
Function is sharply kinked at the reference point and loss averse –
steeper for losses than for gains by a factor of ~2-2.5
Prospect theory is concerned with short-term outcomes and the value
function presumably reflects an anticipation of the valence and intensity of
emotions that will be experienced at moments of transition from one state
to another
Rational agent model focusses on final outcomes and the long-term
But utility can’t be divorced from emotion and emotions are
triggered by changes
A theory of choice that completely ignores feelings such as the pain
of losses and the regret of mistakes is not only descriptively
unrealistic, it also leads to prescriptions that do not maximize the
utility of outcomes as they are actually experienced
Loss aversion explains a violation of consumer theory labelled as the
“endowment effect” by Thaler: the selling price for consumption goods is
much higher than the buying price
The value of a good to an individual appears to be higher when the
good is viewed as something that could be lost or given up than
when the same good is evaluated as a potential gain
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