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Behavioral Economics Cheat Sheet
A printable reference covering bounded rationality, cognitive biases, loss aversion, nudges, framing, and prospect theory for grades 10-12.
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Behavioral economics studies how real people make economic decisions when they have limited information, limited time, and emotions. This cheat sheet helps students compare traditional economic models with observed behavior in markets, saving, spending, and policy choices. It is useful because many choices do not follow the assumption that people always calculate the best possible outcome. Understanding these patterns helps explain consumer behavior, business strategy, and public policy. The core ideas include bounded rationality, heuristics, biases, loss aversion, framing effects, and nudges. Instead of assuming people maximize utility perfectly, behavioral economics shows that choices depend on context, defaults, mental shortcuts, and perceived gains or losses. Important tools include comparing expected value, recognizing sunk costs, and understanding how incentives can be designed. These concepts help students evaluate why people sometimes make predictable mistakes.
Key Facts
- Traditional economics often assumes rational choice, meaning people choose the option that gives the greatest expected benefit based on available information.
- Expected value is calculated as EV = probability of outcome x value of outcome, and it helps compare risky choices.
- Bounded rationality means people make satisfactory choices with limited time, information, and mental processing ability.
- A heuristic is a mental shortcut that can speed up decisions but can also create predictable errors.
- Loss aversion means losses usually feel larger than equal-sized gains, so the pain of losing 10.
- The sunk cost fallacy occurs when a person continues an action because of past costs, even when future benefits do not justify continuing.
- Framing effect means people may choose differently when the same information is presented as a gain, loss, risk, or opportunity.
- A nudge changes the choice environment without removing options, such as making retirement saving the default option.
Vocabulary
- Behavioral economics
- Behavioral economics is the study of how psychological, social, and emotional factors affect economic decisions.
- Bounded rationality
- Bounded rationality means people try to make good decisions but are limited by time, information, and cognitive ability.
- Heuristic
- A heuristic is a simple rule or shortcut people use to make decisions quickly.
- Loss aversion
- Loss aversion is the tendency for people to feel losses more strongly than gains of the same size.
- Framing effect
- The framing effect occurs when the way information is presented changes the decision people make.
- Nudge
- A nudge is a small change in how choices are presented that guides behavior while keeping freedom of choice.
Common Mistakes to Avoid
- Assuming every consumer acts perfectly rationally is wrong because behavioral economics shows that emotions, habits, and biases often shape decisions.
- Ignoring opportunity cost is wrong because every choice uses resources that could have been used for the next best alternative.
- Continuing because money has already been spent is wrong because sunk costs cannot be recovered and should not determine future choices.
- Confusing correlation with causation is wrong because two behaviors may move together without one directly causing the other.
- Treating a nudge as a mandate is wrong because a nudge changes the choice environment but does not remove the ability to choose another option.
Practice Questions
- 1 A student has a 40% chance to win 0. What is the expected value of the gamble?
- 2 A movie ticket costs 15 is a sunk cost fallacy.
- 3 A store says a jacket is 25% off its original price of $80. What is the sale price, and how might the discount framing affect a shopper's decision?
- 4 Why might automatically enrolling employees in a retirement savings plan increase participation even if employees are free to opt out?