Glossary
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Heuristic
Mental decision-making shortcut often associated with a particular goal or purpose such as “price sensitive,” “brand loyal” and “discount driven.”
Heuristics are commonly defined as cognitive shortcuts or rules of thumb that simplify decisions, especially under conditions of uncertainty. They represent a process of substituting a difficult question with an easier one (Kahneman, 2003). Heuristics can also lead to cognitive biases. There are disagreements regarding heuristics with respect to bias and rationality. In the fast and frugal view, the application of heuristics (e.g. the recognition heuristic) is an “ecologically rational” strategy that makes best use of the limited information available to individuals (Goldstein & Gigerenzer, 2002).
Hindsight Bias
Effect (‘knew it all along” effect) occurring when a rationale for a prior decision or conclusion is used to explain a current decision or conclusion. This may include the incorrect recollection of the circumstances of the prior decision or conclusion and/or the belief that the new decision or conclusion was the same or “predictable.”
This bias, also referred to as the ‘knew-it-all-along effect’, is a frequently encountered judgment bias that is partly rooted in availability and representativeness heuristics. It happens when being given new information changes our recollection from an original thought to something different (Mazzoni & Vannucci, 2007). This bias can lead to distorted judgments about the probability of an event’s occurrence, because the outcome of an event is perceived as if it had been predictable. It may also lead to distorted memory for judgments of factual knowledge. Hindsight bias can be a problem in legal decision making. In medical malpractice suits, for example, jurors’ hindsight bias tends to increase with the severity of the outcome (e.g. injury or death) (Harley, 2007).
Homo Economicus
The term homo economicus, or ‘economic man’, denotes a view of humans in the social sciences, particularly economics, as self-interested agents who seek optimal, utility-maximizing outcomes. Behavioral economists and most psychologists, sociologists, and anthropologists are critical of the concept. People are not always self-interested (see social preferences), nor are they mainly concerned about maximizing benefits and minimizing costs. We may make decisions under uncertainty with insufficient knowledge, feedback, and processing capability (bounded rationality); we sometimes lack self-control; and our preferences change, often in response to changes in decision contexts.
IKEA Effect/Bias
Overvaluation of a product, belief or process in which there was participation in its development or completion. Related to the Endowment Effect but does not require ownership.
While the endowment effect suggests that mere ownership of a product increases its value to individuals, the IKEA effect is evident when invested labor leads to inflated product valuation (Norton et al., 2012). For example, experiments show that the monetary value assigned to the amateur creations of self-made goods is on a par with the value assigned to expert creations. Both experienced and novice do-it-yourselfers are susceptible to the IKEA effect. Research also demonstrates that the effect is not simply due to the amount of time spent on the creations, as dismantling a previously built product will make the effect disappear.
The IKEA effect is particularly relevant today, given the shift from mass production to increasing customization and co-production of value. The effect has a range of possible explanations, such as positive feelings (including feelings of competence) that come with the successful completion of a task, a focus on the product’s positive attributes, the relationship between effort and liking (Norton et al., 2012), a link between our creations and our self-concept (Marsh et al., 2018), as well as a psychological sense of ownership (Sarstedt et al., 2017). The effort heuristic is another concept that proposes a link between perceived effort and valuation (Kruger et al., 2004).
Identity Economics
Identity economics suggests that we make economic decisions based on monetary incentives and our identity. A person’s sense of self or identity affects economic outcomes. This was outlined in Akerlof and Kranton’s (2000) seminal paper which expanded the standard utility function to include pecuniary payoffs and identity economics in a simple game-theoretic model of behavior, further integrating psychology and sociology into economic thinking.
When economic (or other extrinsic) incentives are ineffective in organizations, identity may be the answer: A worker’s self-image as jobholder and her ideal as to how her job should be done, can be a major incentive in itself (Akerlof & Kranton, 2005).
Incentives
An incentive is something that motivates an individual to perform an action. It is therefore essential to the study of any economic activity. Incentives, whether they are intrinsic or extrinsic (traditional), can be effective in encouraging behavior change, such as ceasing to smoke, doing more exercise, complying with tax laws or increasing public good contributions. Traditional incentives can effectively encourage behavior change, as they can help to both create desirable and break undesirable habits. Providing upfront incentives can help the problem of present bias – people’s focus on immediate gratification. Finally, incentives can help people overcome barriers to behavior change (Gneezy et al., 2019).
Inequity Aversion
Social approbation against participating in decisions that result in unequal distributions of wealth, value or prestige.
Human resistance to inequitable outcomes is known as ‘inequity aversion’, which occurs when people prefer fairness and resist inequalities (Fehr & Schmidt, 1999). In some instances, inequity aversion is disadvantageous, as people are willing to forego a gain in order to prevent another person from receiving a superior reward. Inequity aversion has been studied through experimental games, particularly dictator, ultimatum, and trust games. The concept has been applied in various domains, including business and marketing, such as research on customer responses to exclusive price promotions (Barone & Tirthankar, 2010) ) and “pay what you want” pricing (e.g. Regner, 2015).
Inertia
Stable state associated with little change in beliefs, behavior, commitments, relationships or decisions.
In behavioral economics, inertia is the endurance of a stable state associated with inaction and the concept of status quo bias (Madrian & Shea 2001). Behavioral nudges can either work with people’s decision inertia (e.g. by setting defaults) or against it (e.g. by giving warnings)(Jung, 2019).
In social psychology, the term inertia is sometimes also used in relation to a persistence in (or commitments to) attitudes and relationships.
Information Avoidance
Information avoidance in behavioral economics (Golman et al., 2017) refers to situations in which people choose not to obtain knowledge that is freely available. Active information avoidance includes physical avoidance, inattention, the biased interpretation of information (see also confirmation bias) and even some forms of forgetting. In behavioral finance, for example, research has shown that investors are less likely to check their portfolio online when the stock market is down than when it is up, which has been termed the ostrich effect (Karlsson et al., 2009). More serious cases of avoidance happen when people fail to return to clinics to get medical test results, for instance (Sullivan et al., 2004).
While information avoidance is sometimes strategic, it can have immediate hedonic benefits for people if it prevents the negative (usually psychological) consequences of knowing the information. It usually carries negative utility in the long term, because it deprives people of potentially useful information for decision making and feedback for future behavior. Furthermore, information avoidance can contribute to a polarization of political opinions and media bias.
Intertemporal Choice
Study of the impact of different periods of time in the future on the likelihood of selecting choice alternatives differing in risk, payoff or likelihood of occurrence. In most cases, the likelihood of selecting a positive outcome is higher the sooner it occurs in the future. (See Present Bias.)
Intertemporal choice is an area of research concerned with the relative value people assign to payoffs at different points in time. It generally finds that people are biased towards the present (see present bias) and tend to discount the future (see time discounting).
Less-is-better Effect
When objects are evaluated separately rather than jointly, decision makers focus less on attributes that are important and are influenced more by attributes that are easy to evaluate. The less-is-better effect suggests a preference reversal when objects are considered together instead of separately. One study presented participants with two dinner set options. Option A included 40 pieces, nine of which were broken. Option B included 24 pieces, all of which were intact. Option A was superior, as it included 31 intact pieces. When evaluated separately, individuals were willing to pay a higher price for set B. In a joint evaluation of both options, on the other hand, Option A resulted in higher willingness to pay (Hsee, 1998).
Licensing/Self-licensing Effect
Higher likelihood of selecting a choice option considered “bad” or immoral, after selecting an option considered “good” or moral.
Also known as ‘self-licensing’ or ‘moral licensing’, the licensing effect is evident when people allow themselves to do something bad (e.g. immoral) after doing something good (e.g. moral) first (Merritt et al., 2010). The effect of licencing has been studied for different behavioral outcomes, including donations, cooperation, racial discrimination, and cheating (Blanken et al., 2015).