Behavioral Economics

AY2025/2026 Semester 1

The above figure depicts the Moller Franz illusion. The lengths of the three lateral lines above appear to be different, although they are of the same length. The cognitive function of our brain tricks us into thinking that they are different. Behavioral Economics studies how psychological limitations influence economic decision makings. In particular, it focuses on how adding important and more realistic human psychological attributes, which include: 1. Bounded rationality; Why people sometimes make seemingly irrational decisions such as taking more risks when they experience losses and being more risk-averse when they experience gains? 2. Bounded willpower; Why people often have difficulties in carrying out activities and actions that they had already earlier planned? For example, often, people desire to save more for retirement but unable to commit to doing so because they face the temptation to spend their money now. 3. Bounded self-interest; Why are people not entirely selfish as assumed in the standard economics analysis? They often are willing to sacrifice their monetary payoffs to uphold fairness and (or) to help unfortunate others. Thus, economics agents are not solely motivated by individual utility maximization. All these attributes can have profound impacts on the predictions of the standard economic models and the way we craft economic and social policies.