Behavioural Economics

Rational choice theory is a concept that assumes people make rational choices which align to their own self-interest. Each individual is said to weigh up the cost and benefits and come to a rational choice.

Illusory correlation occurs when we incorrectly believe that two variables have a relationship with each other. The connection between the two variables is, in effect, an illusion.

The Pygmalion effect is where an individual’s performance is influenced by others’ expectations. In other words, higher expectations lead to higher performance.

Prospect theory is based upon the premise that individuals value losses and gains differently.

Groupthink is the tendency for individuals to agree with each other in a group setting in order to conform and keep harmony. This can contribute to inefficient decision making as ideas and thoughts go unchallenged in favour of cohesion.

The availability heuristic is where recent memories are weighted more significantly. They are given greater consideration in decision making due to the recency effect.

Hindsight bias is where an individual claims to have been able to predict an event after it has happened.

The Hawthorne Effect occurs when individuals adjust their behaviour as a result of being watched or observed. For instance, employees may work harder and more diligently knowing their manager is closely watching, or children behave better because they are being watched by their parents.

A Moral Hazard is where an individual becomes reckless because they know another party will pay for the effects of their actions.

Game theory is the study of strategic decision making between individuals. Although termed ‘game theory’, it refers to any interaction between multiple people where each person’s pay off is affected by the decision made by others.