Behavioural Economics Glossary

We created this A-Z glossary of scientific terms pertaining to human behavior to help our customers understand the “knowing-doing gap”. If you do nothing more than glance through this list, you will gain a clear understanding why systems and processes developed purely from theoretical concepts fail to produce the desired result when implemented in the real world. Systems fail when leaders fail to account for human behavior in the design process! Don’t let that happen to your project or business. Behavioral economics is key to designing systems and processes that work.

Action bias

“Action bias” is a term used to describe the tendency people have to take action in order to feel like they’re in control of a situation, even when doing nothing might be the better choice. This can happen when we feel pressure from others or when we’ve had bad experiences in the past. For example, a goalie might jump to one side during a penalty kick even though it’s statistically better to stay in the middle. This is because they feel like they have to do something to show they’re trying their best.

Affect heuristic

The “affect heuristic” is when we rely on our emotions and how we feel about something to make quick judgments, rather than thinking things through logically. For example, if we have a negative feeling towards nuclear power, we might focus more on the risks and less on the benefits when we’re under time pressure. This can affect how we make decisions about things like product innovations or pricing. It’s similar to other heuristics, like the availability heuristic, where we make judgments based on what comes to mind quickly.

Altruism

“Altruism” is when people do things to help others without expecting anything in return. This could be volunteering, donating money to charity, or helping someone in an emergency. Even though it might not benefit them personally, they still choose to do it because they want to help others. This has been studied in experiments where people are asked to share rewards with others, and many choose to give some of the reward to others, not just keep it for themselves. Other related concepts include sacrificing for fairness or to uphold social preferences.

Ambiguity (uncertainty) aversion

Ambiguity aversion is when we prefer options with known risks over unknown risks. It’s like when you have to choose between two things, and one has risks that you know about and the other has risks that you don’t know about. Most of us tend to go for the one with the known risks. This tendency is called ambiguity aversion, and it can affect our decisions in many situations, like investing in the stock market or deciding on medical treatments. It’s important to consider all the information available to us, not just what we already know, to make the best decisions.

Anchoring (heuristic)

Anchoring is a sneaky mental shortcut that happens when the first piece of information you hear becomes your reference point for making decisions. Even if it’s totally random or unrelated to the decision, it can still influence your judgment. This happens a lot when we’re buying things or making estimates. For example, if you see a house that’s super expensive, it might make you think other houses are cheaper than they really are. Advertisers sometimes use this trick by putting limits or slogans to make you buy more than you intended.

Asymmetrically dominated choice

The asymmetrically dominated choice, also known as the decoy effect, is a phenomenon in which the presence of a third option can influence our decision-making process. When we are faced with two options, adding a third option that is less attractive and inferior to one of the original options can make that option more appealing. This can happen in various situations, such as when choosing between products or deciding which movie to watch. The decoy effect can be used by marketers to influence our choices by strategically presenting options that steer us towards their desired outcome.

Availability heuristic

The availability heuristic is a mental shortcut where we make judgments based on how easily we can remember an example or instance. For example, we might think a certain disease is common because we recently heard a lot about it in the news, even if it’s actually rare. This can also affect how we make decisions about buying products or investments. Basically, the more easily something comes to mind, the more likely we are to think it’s true or important.

Behavioural economics

Behavioral economics is a way of understanding how people make decisions about money and resources. It suggests that humans aren’t always completely rational when it comes to money, and that our behavior can be influenced by things like our emotions, social pressures, and limited self-control. This field looks at how people actually behave, rather than just how they “should” behave according to traditional economic theory.

Bias

Bias refers to a tendency or inclination towards a particular point of view or perspective. In the context of decision-making and judgment, bias can influence our perceptions, attitudes, and behaviors. There are many types of bias, including confirmation bias (seeking out information that confirms our beliefs), hindsight bias (thinking that we knew something was going to happen after it has happened), and availability bias (judging the likelihood of an event based on how easily it comes to mind). It’s important to be aware of our biases and try to evaluate situations objectively.

Bounded rationality

Bounded rationality is a way of saying that our thinking isn’t always perfectly logical or rational. We have limits to how much information we can process and how much time we have to make decisions. This idea challenges the idea that we always make decisions that are in our best self-interest, as traditional economics suggests. Bounded rationality is a key idea in behavioral economics, which looks at how real people actually make decisions in the world.

Bubble (as in Economic)

An economic bubble happens when the price of something, like stocks or houses, goes up way higher than it should be. This can happen because people get really excited and start buying a lot, even if the thing isn’t really worth that much. People can be influenced by things like stories and emotions, and they might not think about the real value of the investment. When the bubble bursts, the price drops suddenly and a lot of people lose money.

Business

Business is an organization or enterprise that is engaged in commercial, industrial, or professional activities with the aim of generating revenue and earning a profit. It involves the production, buying and selling of goods or services to customers, clients, or other businesses. Business may take the form of a sole proprietorship, partnership, corporation, or other legal structure, and may operate in various sectors such as manufacturing, retail, finance, healthcare, and technology. The ultimate goal of any business is to create value for its stakeholders, including shareholders, employees, customers, and the community at large.

Certainty/possibility effects

When it comes to evaluating the possibility of gains or losses, people’s emotions don’t follow a linear path. This means that a small increase in the chances of winning a prize (say, from 50% to 60%) doesn’t feel as exciting as a jump from 95% to 100%. We also tend to be more attracted to small possibilities than to moderate ones – that’s why gambling can be so alluring. Interestingly, studies show that people with gambling problems aren’t necessarily bad at assessing the probability of losing or being averse to losses, but they tend to be more willing to take risks and more drawn to the possibility of winning, even if the odds are slim.

Choice architecture

Choice architecture refers to the way the context is designed to influence the choices people make. It’s like setting up a path for people to follow and nudging them in the right direction. For example, organizing healthy food at the front of a cafeteria line can encourage people to choose healthier options. This approach also includes other techniques such as defaults, framing, and decoy options. By strategically using these behavioral tools, choice architects can guide people towards making better decisions without taking away their freedom of choice.

Choice overload

Choice overload, or overchoice, is the feeling of struggling to choose between too many options when shopping or making a decision. It can lead to unhappiness, decision fatigue, and avoidance of making a decision altogether. Factors contributing to overchoice include the number of options, time constraints, and preference uncertainty. To counteract it, simplifying attributes or reducing the number of options may be helpful, but offering more choice in areas where people feel ignorant, like wine, can also be beneficial. Conversely, in areas where people feel knowledgeable, like soft drinks, fewer options may be better.

Chunking

Chunking is a technique people use to make information easier to understand and remember. It involves reorganizing information into smaller groups or “chunks.” For example, splitting a phone number into three parts makes it easier to remember. Research suggests that humans can best recall seven plus or minus two units of information, and chunking is most effective when four to six chunks are created. However, people can learn to increase the size of chunks over time. In behavioral science, chunking is also used to break down processes or tasks into more manageable pieces, such as in UX design or mobile nudging in the banking sector.

Cognitive bias

A cognitive bias is a type of thinking error that can cause our judgments to deviate from what’s considered desirable or logical. These biases can be caused by mental shortcuts called heuristics, and they can be motivated or not. Some biases, like those caused by errors in processing information, don’t reflect a person’s motivation. Other biases, especially those that benefit us, are more motivated. However, it’s important to avoid seeing biases everywhere, as some may not actually be biases.

Cognitive dissonance

Cognitive dissonance is a term from social psychology that describes the uncomfortable feeling we get when we hold two conflicting ideas or beliefs at the same time. To reduce this tension, we may change our attitudes, beliefs, or actions. For example, smokers might convince themselves that the evidence linking smoking to cancer is not convincing, even though deep down they know it is. Researchers have used the concept of cognitive dissonance to try to change people’s behavior by making them aware of their actions and then encouraging them to publicly commit to changing them. This can be an effective way to bring about change.

Commitment

Commitment is a powerful tool for achieving behavior change, such as in dieting or saving money. Essentially, commitments are promises we make to ourselves or others to do something specific. The more difficult it is to break a commitment, the more effective it tends to be. People are motivated to keep their commitments to maintain a positive self-image and to avoid reputational damage or cognitive dissonance. In fact, studies have shown that publicly committing to a behavior change can increase the likelihood of following through with it. For example, a hotel experiment found that guests who made a commitment to reuse towels at check-in and wore a “Friend of the Earth” lapel pin were 25% more likely to reuse their towels during their stay. Commitment is related to the behavior change technique of goal setting and the principle of reciprocity.

Confirmation bias

Confirmation bias is when people tend to search for, interpret, and remember information in a way that confirms their existing beliefs and ideas. It’s like having a filter that only lets in information that supports what you already think. This bias is not just limited to personal beliefs and opinions, but it can also affect how people approach scientific research and consumer decisions. For example, if you already have a favorite brand, you might only look for reviews that support your opinion and ignore any negative feedback. It’s important to be aware of confirmation bias and actively seek out different perspectives and evidence to avoid making biased judgments.

Control premium

In behavioral economics, the control premium means that people are willing to give up some potential rewards in order to have control over their own outcomes. For example, if given a choice to bet on themselves or someone else answering a question correctly, people will often choose to bet on themselves even if it means potentially winning less money. This shows that people value having control over their own outcomes and are willing to sacrifice some potential rewards for it.

Culture

In the context of business or economics, culture refers to the shared values, beliefs, behaviors, and customs that shape the way individuals and groups within an organization interact with one another and approach their work. It is the collective identity of an organization, shaped by its history, traditions, and social norms. The culture of an organization can have a significant impact on its performance and success, influencing everything from its decision-making processes to its ability to attract and retain employees. It is a dynamic and evolving process that is passed down through generations of employees and adapted to changing circumstances and challenges.

Curse of knowledge

The curse of knowledge is when someone knows a lot about a topic and has a hard time understanding what it’s like for someone who doesn’t know as much. This can cause problems in things like setting prices or estimating how long it will take someone to do a task.
Here’s a fun example: imagine you know how to play a really popular song like “Happy Birthday” on the piano. You try to tap out the rhythm on a table and have someone guess what song it is. You might think it’s really easy to guess, but the person listening might not know the song at all and have a hard time guessing. This is because you, the “tapper,” have the curse of knowledge and can’t imagine what it’s like to not know the song as well as you do.

Cycles

In economics or business, a cycle refers to a recurring pattern of events or activities that follow a certain sequence and occur over a specific period of time. These cycles can be related to various economic indicators, such as production, employment, and prices. Economic cycles are typically characterized by periods of expansion, peak, contraction, and trough, and they can be influenced by various factors, such as government policies, international trade, and consumer behavior. Understanding these cycles is important for businesses and policymakers to make informed decisions about investments, production, and economic policies.

Decision fatigue

Have you ever found yourself exhausted after making a lot of decisions? That’s because making decisions can be tough and requires effort, just like any other activity. Long periods of decision-making can lead to poor choices, and this is called decision fatigue. It’s like running a mental marathon and can leave you feeling drained. When you experience decision fatigue, it can be harder to make good choices, and you might find it more difficult to control your impulses. It’s important to take breaks and give your brain a chance to recharge, just like you would rest your muscles after a physical workout. Decision fatigue is closely related to other concepts, such as choice overload and ego depletion.

Decision staging

When we have to make a big decision, like buying a car, we usually break it down into smaller parts and make decisions step by step. This is called decision staging. We start by figuring out what information we need to make a choice, then we compare our options based on a few important factors, and finally we make our decision. People who help others make decisions, like car salespeople, can make the process easier by breaking it down into different stages. They can also guide us through each stage by helping us compare our options at different times in the decision-making process. This can help us make a better decision in the end.

Decoy effect

Have you ever had trouble deciding between two options, only to find that adding a third option made the decision easier? This is called the decoy effect. It happens when people’s preferences for one option over another change after adding a third, similar but less attractive option. For example, if you had to choose between a fancy pen and $6 cash, you might pick the pen. But if a less fancy pen was added as a third option, you might choose the fancy pen because it seems like a better value compared to the less fancy pen. This effect is not just limited to consumer products, it can also be seen in employee selection, apartment choices, and even nudging people to get cancer screening.

Default (option)

Default options are like pre-set choices that automatically happen if someone doesn’t actively choose something else. For example, if you don’t choose a specific ringtone for your phone, it might automatically be set to a default one. Defaults are a powerful way to influence people’s decisions because they require no effort to accept. For example, many countries have made it so that people automatically contribute to their retirement savings, unless they actively choose not to. Another example is organ donation – some countries make it so that people are automatically registered as donors, unless they opt out. Defaults can be a helpful nudge when people are unsure about what to do, and can also be seen as a recommended course of action.

Delusion of competence (Dunning-Kruger effect)

The Dunning-Kruger effect is when someone doesn’t realize that they’re not good at something. They might think they’re great at it, but in reality, they’re not. This can cause problems in decision-making, like when a boss promotes a bad product or when a person thinks they’re good at singing but they’re not.

Dictator game

The dictator game is a type of experiment that tries to see if people will act in a kind and generous way. In the game, one person is given some money and gets to decide how much to give to someone else. Unlike other games, the person getting the money doesn’t get to choose whether to accept or not. Some people wonder if this game really shows how kind people are or if there’s something else going on.

Discounting or Time discounting

Discounting, or time discounting, is the tendency of people to value a reward less if it is delayed in time. This means that people are willing to wait less for larger rewards, and more for smaller rewards. For example, someone might choose to receive $50 now instead of waiting a month for $60.

Disposition effect

Have you ever held onto a stock that was losing value instead of selling it? Or sold a stock that had made gains instead of keeping it? That’s called the disposition effect, and it’s a common behavior among investors. Basically, people tend to feel the pain of a loss more strongly than the pleasure of a gain, so they hold onto losing investments hoping they’ll turn around. At the same time, they tend to sell winning investments to lock in gains. It’s a result of our emotions and how we perceive risk and reward.

Diversification bias

Diversification bias is when people choose a wide variety of items for future consumption, but when it comes time to actually use them, they only prefer a few. This happens because people often overestimate their need for diversity. Sequential choices usually lead to greater satisfaction because we get to choose based on our immediate preferences. For example, I might download a mix of music genres for my vacation but end up only listening to my favorite one. When people choose between “virtues” (like high-brow movies or healthy foods) and “vices” (like low-brow movies or indulgent foods), they usually choose more virtues in an attempt to balance out their indulgences.

Dual-self model

Have you ever felt torn between your desire for immediate gratification and your long-term goals? That’s where the dual-self model comes in. This model recognizes that we have two “selves”: a patient, forward-thinking self and a myopic, impulsive self. These two selves can conflict when it comes to decisions like saving money. Researchers have tried to find ways to make people feel more connected to their future selves, like using virtual reality to show what they might look like in the future.

Dual-system theory

The dual-system theory is a way of understanding how our minds work. It suggests that we have two systems: System 1, which is quick and automatic, and System 2, which is slower and more deliberate. When we make decisions, System 1 often kicks in first and can lead us to use shortcuts or biases. Factors like being busy, distracted, or in a good mood can make System 1 more dominant, while important decisions or accountability can bring in System 2.

Efficient market hypothesis

The efficient market hypothesis is a theory that says the market price of a security accurately reflects its true value. This means that all available information is already incorporated into the market price. However, behavioral finance suggests that individual trading behavior can also affect prices, leading to anomalies like bubbles. In other words, people don’t always make perfectly rational decisions when buying and selling assets, which can create temporary distortions in the market.

Ego depletion

Have you ever tried to resist the temptation of eating a piece of cake, only to later give in and eat the whole thing? That’s what ego depletion feels like. It’s a concept from psychology that says our ability to exercise self-control is like a muscle that can get tired and weakened. When we use a lot of self-control, like trying to resist a temptation, we can deplete our willpower and become less able to control our behavior later on. Studies have found that ego depletion can lead people to make impulsive decisions, like choosing candy over healthy snacks. However, some researchers now question whether this idea of “ego depletion” is really accurate.

Elimination-by-aspects

Elimination-by-aspects is a nifty little trick that people use to make choices more manageable. Instead of trying to evaluate all options at once, decision makers gradually reduce the number of alternatives in a choice set by focusing on one aspect at a time. For example, when choosing a hotel, they may first eliminate all options with fewer than three stars, then further narrow down the list by looking at distance from the beach or guest reviews. Eventually, only one option remains. This approach can save time and effort, but it also runs the risk of overlooking important factors that were not considered early on..

(Hot-cold) Empathy gap

The hot-cold empathy gap refers to a cognitive bias where people underestimate how much their visceral states (like hunger, pain, or anger) can influence their behavior or preferences. This can lead to poor decision making, such as cancer patients choosing undesirable treatment options or smokers underestimating their risk of becoming addicted.

Endowment effect

Have you ever noticed that you tend to value something more just because it belongs to you? That’s called the endowment effect. Even if the thing isn’t worth much to other people, you might think it’s really valuable just because it’s yours. This effect is especially strong for things that have personal meaning, like a family heirloom or a concert ticket from your favorite band.

Empathy gap

The empathy gap refers to the tendency for people to underestimate how much their emotions and desires will change in response to future events or situations. For example, someone might say they would never cheat on a test, but when faced with the actual temptation in the moment, they may behave differently than they expected. This gap between prediction and behavior can be influenced by a variety of factors, such as time pressure, cognitive load, and emotional arousal. Understanding the empathy gap can help us better predict and regulate our own behavior.

Extrapolation bias

Extrapolation bias refers to our tendency to assume that current trends and patterns will continue into the future indefinitely. In other words, we overestimate the future impact of current events or circumstances, without taking into account potential changes or disruptions. This bias can be seen in various contexts, such as financial forecasting or economic predictions, where people may assume that past trends will continue without considering the impact of new developments or shifts in the market. It can also lead to overconfidence and risky decision-making, as people may make decisions based on an incomplete or inaccurate view of the future.

Fairness

Fairness is a concept in behavioral science that refers to our preference for equal outcomes. We don’t like it when things are unequal, and this tendency has been observed in various games and experiments. In economics, fairness has been studied in relation to prices and wages. Consumers tend to be more accepting of price increases that are a result of rising costs, rather than short-term growth in demand. Employers sometimes pay more than the minimum wage to encourage employees to reciprocate the fairness. However, perceived unfairness, such as excessive CEO compensation, can lead to reduced work morale.

Fast and frugal

When we make decisions, we often rely on our intuition and quick thinking. Fast and frugal decision-making is all about using shortcuts that are quick and effective. These shortcuts are based on our natural cognitive abilities like memory and perception. They work well when we have limited resources, like time or knowledge. The recognition heuristic is an example of this kind of thinking. It helps us make choices by picking the option that we recognize, even if we don’t know much about it. Overall, fast and frugal decision-making is a smart way to work with the limitations we have as humans.

Fear of Disappointment

This refers to the feeling of being let down or disappointed when something doesn’t go as expected. For example, if someone has a fear of disappointment when it comes to winning $10,000, they may not want to take a risk and try to win.

Fear of missing out

Have you ever felt like you’re missing out on something when scrolling through social media? That feeling of anxiety is called Fear of Missing Out, or FoMO. It’s the fear that others are having fun and exciting experiences that we’re not a part of. This fear drives us to constantly check our feeds and stay informed about what others are doing. It’s related to other biases, like regret aversion and loss aversion, which make us afraid of missing out on opportunities or experiences.

Framing effect

The framing effect is when the way we present a decision can change how attractive it seems. For example, if we talk about the benefits of a decision, it might seem more appealing than if we focus on the negative aspects. This idea comes from prospect theory, which looked at how we make choices based on losses and gains. Framing can be used in different ways, such as highlighting the risks or rewards of a decision or emphasizing different aspects of a message. It’s also important in political communication, where it can influence public opinions.

Gambler’s fallacy

Have you ever heard someone say, “I can’t bet on that number, it just came up last round”? That’s an example of the gambler’s fallacy, a belief that independent events are somehow connected. Despite knowing that each round of a game of chance, like roulette or lottery, is completely unrelated, some people can’t help but feel that a certain number is less likely to come up again.

(Behavioral) Game theory

Game theory is a fancy way of modeling how people make decisions based on the actions of others. It’s like a game of chess, but with real-life scenarios and real people making the moves. In traditional game theory, the focus is on how people act in their own self-interest to maximize their gains. But in behavioral game theory, we take into account how people feel about what others are getting, how they think about the situation, and how they learn from their experiences. Some popular games include those that involve cooperation and fairness, like the ultimatum game, dictator game, and trust game.

Habit

Habits are those things we do almost automatically, without even thinking about them. They’re like routines we’ve learned through repetition, such as brushing our teeth before bed or checking our phone as soon as we wake up in the morning. Habits are formed through a type of learning called associative learning, where actions become linked to specific situations or events. Habits usually involve a cue, a behavior, and a reward. Once we’ve repeated a habit enough times, it becomes automatic and we may not even think about the reason behind it. Habits can be hard to break, and they can even lead to status quo bias, where we prefer things to stay the same rather than change.

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