Behavioral Economics and Real-World Irrationality

The Problem with the "Rational Consumer"

Traditional consumer theory assumes humans:

• Always make rational decisions
• Have full information
• Maximize utility flawlessly

Spoiler alert: We don’t.

Behavioral Economics to the Rescue

Behavioral economics studies how people actually behave — full of biases, mental shortcuts, and irrational preferences.

Common Biases and Heuristics

1. Anchoring
   • Relying too heavily on the first piece of information
   • Ex: If the first jacket you see is $400, a $200 jacket looks cheap
2. Loss Aversion
   • Losses feel ~2x worse than gains feel good
   • People avoid risk when it comes to gains, but take risks to avoid losses
3. Framing Effect
   • Choices are affected by how information is presented
   • "90% fat-free" sounds better than "10% fat"
4. Present Bias
   • Favoring immediate rewards over long-term benefits
   • Classic: choosing junk food now vs. staying fit later

Implications for Markets

• Advertising plays into framing and anchoring
• Retirement plans and savings need "nudges"
• Policies may need to protect consumers from their own biases

Key Takeaways

• Consumers aren't always rational
• Psychological biases affect real-world decisions
• Behavioral economics helps explain why people don't always optimize