Mapping Irrationality
An Introduction To Behavioral Economics
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The mind is like an iceberg, it floats with one-seventh of its bulk above water — Sigmund Freud
On September 9, 2017, Richard Thaler earned the Nobel prize in Economics for his contributions to the field of behavioral economics. That very same week Bitcoin surged above $5000 while Jamie Dimon proclaims Bitcoin investors are stupid. How are the two developments related? Think of how emotions such as fear, greed and anger affect business outcomes and asset bubbles.
Behavioral economics, along with behavioral finance, has come to occupy an important place in explaining financial markets and asset prices. In a way,both disciliplines try to explain how human thought works using economic models. Perhaps, the future of behavioral economics is closely tied to the advances in Artificial Intelligence. At the end, both social science and science are attempting to recreate human behavior.
This article explains how behavioral economics affects your life and how it can help you understand forces that affect your financial and economic well being.
The Foundations
Economics is a study of choice. Choices have to be made because most humans have finite resources and choices have trade offs. Trade-offs or the things given up to enjoy other things are known in economics as ‘opportunity costs’. Perhaps, the most important finite resource that humans have is time. Choosing what you do with your time decides how much of a different resource you will have access to i.e. how much money you make.
How people spend economic resources can, sometimes, be explained by the study of human psychology including biases, behaviors, social and emotional factors. Every decision to spend economic resources by an individual or an institution has an effect on various variables including but not limited to asset prices, market movements and the broader economy. Today, the choices that multinational institutions or important individuals such as the chairmen of Central Banks and other such global leaders make have an impact on the global economy because of complex interlinkages created by globalization. Think of chaos theory and the effects…
