Behavioral economics is primarily interested in explaining why people often behave differently than a rational agent, departing from one of the basic assumptions of classical economics. The same is the case with behavioral finance, which departs from the assumptions of traditional finance.
Behavioral economics has observed a variety of behaviors of ordinary people that violate the assumption of rationality in consumer decision-making. Here are some examples:
- Information avalanche: Consumers have to compare many options and features, leading to confusion, random choices, or no decisions at all.
- Heuristics: Consumers often adopt shortcuts in their decisions. For example, instead of analyzing all the information, they limit themselves to buying the same things as their friends or family.
- Heritage: Consumers tend to be reluctant to change suppliers or brands for fear of making a mistake.
- Inertia: Consumers tend not to switch providers when they have to make an effort (e.g., turn off auto-renewal).
- Myopia: Consumers tend to have a short-term vision that prioritizes current satisfaction over looking forward to future satisfaction. So, for example, when decisions need to be made about long-term investments or retirement savings, consumers do not give sufficient consideration to future benefits.
- Framing: Consumers are influenced by the way or framework in which information is presented. Sometimes the same data presented in different ways leads to different decisions.
- Risk aversion: The preference for avoiding a loss is greater than the preference for gaining something.