When Psychology Meets Economics


1) Behavioural Economics = Psychology + Economics. The understanding of human behaviour and decision making.
2) Goal gradient theory = Goal motivation changes as one gets closer to the target. The closer one gets to the target; the greater motivation is to achieve it.
3) Loss Aversion or Loss Principles = For most, the “pain” or a loss if greater than the “pleasure” of an equivalent gain. People tend to be more motivated to avoid a monetary loss of $100 than they are to gain $100.
4) Endowment Effect = We tend to assign more value to objects or things merely because we own them, even if the ownership is for a few minutes long.
5) Anchoring Principle = People tend to use irrelevant information as a reference for evaluating or estimating an unknown value or new information. When anchoring, people base decisions or estimates on events or values known to them, even though these facts may have no bearing on the actual event or value.
6) Reference Point = What you expect to pay for something changes that value that you receive based on the price you pay. If you expect to pay a higher amount than you do, the pleasure received from the purchase goes up. The same goes for the opposite.
7) “Choice and the decision to take action are separate psychological transactions.”
8) Framing Principles = Different ways which choices are framed can have an impact on the decisions and subsequent behaviour of people. (E.g., Framing of early registration for a class as a penalty or a discount)
9) Fairness or Perceived Fairness Principle = People are highly influenced by a sense of fairness or a perceived lack of fairness. (E.g., Mathew Liebermann, PhD Research: Ultimatum Game – 2 players split $10. One person makes an offer of a split, and the other decides if they will accept the offer or reject it (if they accept the money is split as offered if rejected, no one receives anything). How much do you usually have to offer for the 2nd person to accept? Responder usually rejects offer unless it is over $3 – throwing away money just because they feel slighted and not a fair distribution of funds.)
10) Hedonic Principle = Luxurious awards are more motivating than equivalent cash or other rewards. These types of awards fulfil our desire for pleasure and are perceived as more valuable than their economic cost.
11) Unique Fit Principle = When we feel that we have a unique advantage or a specially tailored program, we tend to be more motivated. This sense of unique fit fuels our desire to perform even with increased difficulty. (E.g. Low and High-cost entry free for a Credit Card program.)
12) Regret Principle = You feel more pain of loss if you believed that you were close to avoid the loss. “Happiness frequently depends not on where we are now, but how easily we perceive we might be elsewhere, or in another, better situation.” (E.g. Missing a flight by 30 minutes: Misery Index = High, Missing a flight by 1 minute: Misery Index = Super High)
13) Decoy Effect = Preferences for items change when a third option that is asymmetrically dominated (closer to one option than the other) is presented.
14) Motivating uncertainty effect = Research shows that in most instances, we are more motivated to reach a goal with an uncertain reward than one with a fixed reward.
15) Self-Delusion Principle = We tend to think that we are more honest, cooperative, rational etc. than others. People tend to think more positively about themselves than they are.
16) Time Principle = The concept that instant rewards are more desirable than future ones. (E.g. People would rather receive $200 now compared to $210 over a month.) We tend to discount the value of the later reward, by a factor that increases with the length of the delay.
17) Size Principle = We feel that outcomes are more likely to occur if they are classified with a large category as opposed to a smaller category. We mistakenly believe that items in larger categories have a higher probability of being picked than those in smaller categories. We are also more likely to act if we think an action is associated with a larger category.
18) The Bandwagon Effect = Tendency of people to assume the actions of others reflect the correct behaviour in each situation. We look for cues in how others behave and copy their behaviour in unknown situations. Status quo or knowledge bias – Tendency of people to choose the option they know best rather than choosing the best option.
19) Top Dog Effect = When powerful people work together on a short- term project, their output (persistence, creativity, agreement) diminishes. Research showed that they tended to focus on who gets to be “top dog” and have the most power.
20) Relative Deprivation Theory = We compare ourselves to those in our immediate circle – not the larger whole, leading high-performing, smart people to feel less so when they are grouped with other high- performing smart people. This tends to decreases confidence, motivation and self-efficacy beliefs.

Enjoyed this list? Learn more with the following books:
Misbehaving: The Making of Behavioural Economics
Doughnut Economics: Seven Ways to Think Like a 21st-Century Economist
The Invisible Gorilla: How Our Intuitions Deceive Us
Nudge: Improving Decisions About Health, Wealth, and Happiness
The Person and the Situation: Perspectives of Social Psychology
Predictably Irrational, Revised and Expanded Edition: The Hidden Forces That Shape Our Decisions
Freakonomics: A Rogue Economist Explores the Hidden Side of Everything

Although we might be oblivious at times, to the effects of behavioural psychology occurring in our daily lives, I hope this summary can provide insights into how market decisions are made and the mechanisms that drive those choices.

Like this? Be sure to share it with your friends, family and loved ones to understand how psychology and economics play a role in our daily lives.

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