Misbehaving

“Econs” is a term Thaler uses to describe the hypothetical, perfectly rational agents in traditional economic models. These agents are characterized by their ability to make optimal decisions that maximize utility. Thaler contrasts Econs with real humans, who often exhibit biases and irrational behaviors, challenging the traditional economic assumption of rational decision-making.

The Endowment Effect is a psychological phenomenon where individuals ascribe more value to things simply because they own them. Thaler explores this concept in Misbehaving, illustrating how it contradicts the traditional economic notion of consistent valuation. This effect is a critical example of how human emotions and psychological ownership influence economic decisions.

Mental accounting refers to the tendency of individuals to categorize and treat money differently based on its source, intended use, or other psychological factors. Thaler introduces this concept to explain irrational financial behaviors, such as treating “found money” differently from earned income. This term underscores the discrepancy between the rational, fungible view of money in classical economics and the subjective, compartmentalized approach in behavioral economics.

Nudge Theory, a concept popularized by Thaler, involves subtly guiding individuals toward beneficial behaviors without restricting their freedom of choice. Thaler discusses how understanding human behavior and cognitive biases can lead to designing policies and systems that “nudge” people toward more rational decisions, illustrating the practical applications of behavioral economics.

Prospect Theory, developed by Daniel Kahneman and Amos Tversky, is discussed by Thaler as an alternative to the traditional utility theory. It posits that people value gains and losses differently, leading to irrational decision-making under risk. Thaler uses Prospect Theory in Misbehaving to explain phenomena like loss aversion and the asymmetrical valuation of risks and rewards.

Rational Choice Theory is a framework in traditional economics based on the assumption that individuals make decisions that maximize their utility. Thaler critiques this theory, providing evidence of how real-world decisions often deviate from this model due to cognitive biases, emotions, and other human factors.

The Sunk Cost Fallacy is the tendency to continue an endeavor due to the amount of resources already invested, regardless of the future benefit or cost. Thaler uses this term to highlight how individuals irrationally let past investments influence their current decision-making, challenging the economic principle of rational behavior.