This document summarizes some key concepts from behavioral economics. It introduces the concepts of "Homo Economicus" which assumes people are perfectly rational, and "Homo Sapiens" which recognizes people sometimes and even always make irrational decisions. It discusses the work of Amos Tversky and Daniel Kahneman who founded behavioral economics and experiments showing people rely on heuristics and face biases. Examples of heuristics discussed include availability heuristic and representative heuristic. Mental accounting and sunk costs are also summarized.

1. Making Sense of Irrationality!
“Opening the Black Box”
By: Humayun Khan

2. Who is this “Homo Economicus”?
•Supremely RATIONAL
• Examines Evidence
• Conducts a cost/benefit
analysis before making a
decision

3. Introducing “Homo Sapiens”
•“Homo Economicus”
model not disproved
because we
“SOMETIMES” make
mistakes.
•The proof lies in that in
certain circumstances,
we “ALWAYS” make
mistakes.

4. Amos Tversky& Daniel Kahneman–
The Founders of Behavioural Economics

5. Question
• A bat and ball cost $1.10 in total. The bat costs
$1 more than the ball. How much does the ball
cost?

6. Two Modes of Thinking
• “I feel it in my GUT!”
Vs.
• “Use your HEAD!”

7. Key Points to Take Away
• Representative Heuristic or The Rule of Typical
Things
• Availability Heuristic or The Example Rule
• Mental Accounting
▫ Sunk Costs

8. Read This!
• Linda is a 31 years old, single, outspoken, and
very bright. She majored in Philosophy. As a
student, she was deeply concerned with issues of
discrimination and social justice, and also
participated in anti-nuclear demonstrations

9. Ask yourselves…
How likely is it that she is:
A) Bank Teller
B) Bank Teller active in the Feminist Movement

10. How it works…
• If it looks like one, than it is one…
• This heuristic uses past learning to make
decisions in the present, and predict the future,
in the face of illogical thinking.

11. Ask yourselves…
Which one causes more deaths?
a) Smoking
b) H1N1

12. Are you more likely to be killed by?
a) b)

13. 30% more likely to be killed by falling
Airplane Parts
• Forget “JAWS”, think more “RUDDER”…

14. How it works…
• When people are asked to judge how frequently
something occur, people consult their memories
for examples
• The easier it is for you find an example of an
event, the MORE LIKELY or FREQUENT you
think it is…

15. Why can’t you get a cab on a rainy day?

16. What to do with all that birthday
money?
• Pay rent, phone bill, utilities bill, cable
bill…NAWWWWWW……
• How about alcohol, ipod, itouch, laptop,
blackberry, or some new clothes…SOUNDS
MORE LIKE IT

17. How it works…
• The concept of mental accounting states, that
the source of the money affects how it is spent.
Pay Check OSAP Scholarship Gift Money
• So, when the cab driver makes his daily amount
in a few hours, he closes the mental account and
goes home, rather then work his shift and make
extra money

18. Imagine…
You arrive at a theatre and discover that you lost
your ticket. Would you pay another $10 to buy
another ticket?

19. Now, Imagine…
• You are going to the play but haven’t bought
your ticket in advance. When you arrive at the
theatre you realize you have lost a $10 bill.
Would you still buy a ticket?

20. Sunk Costs
• Costs that have already been incurred and which
cannot be recovered to any significant degree…

21. That’s All for Now
• I hope you now know or at least have started to
wonder about, why we don’t make sense (all the
time, that is).

22. References:
• Kahneman, Daniel, Paul Slovic, and Amos Tversky. Judgment
Under Uncertainty: Heuristics and Biases. Cambridge, UK:
Cambridge University Press, 1982.
• Gardner, Dan. Risk: Why we fear the things we shouldn’t – and put
ourselves in greater danger. Toronto, Ontario: McClelland &
Steward Ltd., 2008