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Economic (or asset) bubbles form when prices are driven much higher than their intrinsic value (see also efficient market hypothesis). Well-known examples of bubbles include the US Dot-com stock market bubble of the late 1990s and housing bubble of the mid-2000s. According to Robert Shiller (2015), who warned of both of these events, speculative bubbles are fueled by contagious investor enthusiasm (see also herd behavior) and stories that justify price increases. Doubts about the real value of investment are overpowered by strong emotions, such as envy and excitement. Other biases that promote bubbles include overconfidence, anchoring, and representativeness, which lead investors to interpret increasing prices as a trend that will continue, causing them to chase the market (Fisher, 2014). Economic bubbles are usually followed a sudden and sharp decrease in prices, also known as a crash.
People often put off decisions, which may be due to self-control problems (leading to present bias), inertia, or the complexity of decision making (see choice overload). Various nudge tools, such as precommitment, can be used to help individuals overcome procrastination. Choice architects can also help by providing a limited time window for action (see scarcity) or a focus on satisficing (Johnson et al., 2012).
Heuristic in which the emotion associated with a decision option impacts its likelihood of selection.
The affect heuristic represents a reliance on good or bad feelings experienced in relation to a stimulus. Affect-based evaluations are quick, automatic, and rooted in experiential thought that is activated prior to reflective judgments (see dual-system theory) (Slovic et al., 2002). For example, experiential judgments are evident when people are influenced by risks framed in terms of counts (e.g. “of every 100 patients similar to Mr. Jones, 10 are estimated to commit an act of violence”) more than an abstract but equivalent probability frame (e.g. “Patients similar to Mr. Jones are estimated to have a 10% chance of committing an act of violence to others”) (Slovic et al., 2000).
According to neoclassical economics, rational beings do whatever they need to in order to maximize their own wealth. However, when people make sacrifices to benefit others without expecting a personal reward, they are thought to behave altruistically (Rushton, 1984). Common applications of this pro-social behavior include volunteering, philanthropy, and helping others in emergencies (Piliavin & Charng, 1990).
Ambiguity (Uncertainty) Aversion
Ambiguity aversion, or uncertainty aversion, is the tendency to favor the known over the unknown, including known risks over unknown risks. For example, when choosing between two bets, we are more likely to choose the bet for which we know the odds, even if the odds are poor, than the one for which we don’t know the odds.
Decision shortcut in which the ability of the respondent to recall information about the choice options impacts their likelihood of selection.
Availability is a heuristic whereby people make judgments about the likelihood of an event based on how easily an example, instance, or case comes to mind.
Discipline that includes a psychological or sociological explanation of economic behavior.
The field of behavioral economics studies and describes economic decision-making. According to its theories, actual human behavior is less rational, stable, and selfish than traditional normative theory suggests (see also homo economicus), due to bounded rationality, limited self-control, and social preferences.