Cognitive Biases

Behavioral economics combines elements of economics and psychology to understand how and why people behave the way they do in the real world

A

Availability Heuristic
Affect Heuristic
Anchoring

B

Bounded Rationality

C

Cognitive Dissonance
Confirmation Bias
Certainty Effect
Choice Overload
Commitment

D

Dunning-Kruger Effect
Diversification Bias
Decision Fatigue
Decoy Effect

E

Elimination By Aspects
Endowment Effect
Ego Depletion

F

Fear Of Missing Out
Framing Effect

G

Gambler's Fallacy

H

Hot-Cold Empathy Gap
Hedonic Adaptation
Herd Behaviour
Hindsight Bias
Halo Effect
Habit

I

IKEA Effect

L

Less Is Better Effect
Licensing Effect
Loss Aversion

M

Mental Accounting

N

Naive Diversification

O

Overjustification Effect
Overconfidence Effect
Optimism Bias

P

Procrastination
Projection Bias
Pain Of Paying
Peak-End Rule
Present Bias
Partitioning
Priming

R

Representativeness Heuristic
Regret Aversion
Reciprocity
Ratio Bias

S

Sunk Cost Fallacy
Social Proof
Scarcity

Z

Zero Price Effect

Affect Heuristic

A mental shortcut that allows people to make decisions quickly by bringing their emotional response into play

They make decisions according to their gut feeling

Researchers have found that when people have a pleasant feeling about something, they see the benefits as high and the risks as low, and vice versa

As such, the affect heuristic behaves as a first and fast response mechanism in decision-making

For example, if someone has harmed you, you quickly arrive at the conclusion that this person is cold and unfriendly

If fact, even if the person didn't harm you on purpose, you may still feel about him or her the same

Anchoring

A cognitive bias that describes the human tendency to rely too heavily on the first piece of information offered (the "anchor") when making decisions

For example, an initial price offered for a used car sets the standard for the rest of the negotiation

Availability Heuristic

A mental shortcut that relies on immediate examples that come to a given person's mind when evaluating a specific topic, concept, method or decision

People tend to heavily weigh their judgments toward more recent information, making new opinions biased toward the latest news

For example, which job is more dangerous - being an American police officer or a logger?

While high-profile police shootings might lead you to think that cops have a more dangerous job, statistics actually show that loggers are more likely to die on the job than cops

This illustrates that availability heuristic helps people make fast, but sometimes incorrect assessment

Bounded Rationality

The idea that in decision-making, people are limited by the information they have, the cognitive limitations of their minds, and the finite time

As a result, they seek for a "good enough" decision and tend to make a satisficing (rather than maximizing or optimizing) choice

For example, during shopping when people buy something that they find acceptable, although that may not necessarily be their optimal choice

Certainty Effect

When people overweight outcomes that are considered certain relative to outcomes that are merely possible

The certainty effect makes people prefer 100% as a reference point relative to other percentages, even though 100% may be an illusion of certainty

Lower percentages or probabilities can be more beneficial in the long run

For example, people prefer a 100% discount on a cup of coffee every 10 days to other more frequent but lower discount offers, even though the second option may save them more money in the long run

Choice Overload

A cognitive process in which people have a difficult time making a decision when faced with many options

Too many choices might cause people to delay making decisions or avoid making them altogether

For example, a famous study found that consumers were 10 times more likely to purchase jam on display when the number of jams available was reduced from 24 to 6

Less choice, more sales

More choice, fewer sales

Cognitive Dissonance

A mental discomfort that occurs when people's beliefs do not match up with their behaviours

For example, when people smoke (behaviour) and they know that smoking causes cancer (cognition)

Commitment

The tendency to be consistent with what we have already done or said we will do in the past, particularly if this is public

For example, researchers asked people if they would volunteer to help with the American Cancer Society

Of those who received a cold call, 4% agreed

A second group was called a few days prior and asked if they would hypothetically volunteer

When the actual request came later, 31% of them agreed

Confirmation Bias

The tendency to search for or interpret information in the way that confirms one's pre-existing beliefs, leading to statistical errors

When people would like a certain idea to be true, they end up believing it to be true

They are motivated by wishful thinking

For example, a person with a low self-esteem is highly sensitive to being ignored by other people, and they constantly monitor for signs that people might not like them

Decision Fatigue

A lower quality of decisions made after a long session of decision making

Repetitive decision-making tasks drain people's mental resources, therefore they tend to take the easiest choice - keeping the status quo

For example, researchers studied parole decisions made by experienced judges and revealed that the chances of a prisoner being granted parole depended on the time of the day that judges heard the case

65% of cases were granted parole in the morning and fell dramatically (sometimes to zero) within each decision session over the next few hours

The rate returned back to 65% after a lunch break and fell again

Decoy Effect

People will tend to have a specific change in preferences between two options when also presented a third option that is asymmetrically dominated

In simple words, when there are only two options, people will tend to make decisions according to their personal preferences

But when they are offered another strategical decoy option, they will be more likely to choose the more expensive of the two original options

For example, when consumers were offered a small bucket of popcorn for £3 or a large one for £7, most of them chose to buy the small bucket, due to their personal needs at that time

But when another decoy option was added - a medium bucket for £5, most consumers chose the large bucket

Diversification Bias

People seek more variety when they choose multiple items for future consumption than when they make choices sequentially on an in the moment basis

For example, before people are going on holiday, they add classical, rock and pop music to their playlist but eventually end up listening to their favourite rock music

Dunning-Kruger Effect

A cognitive bias in which people who are ignorant or unskilled in a given domain tend to believe they are much more competent than they are

In simple words, people who are too stupid to know how stupid they are

For example, a nationwide survey found that 21% of Americans believe that it's very likely that they'll become millionaires within the next 10 years

Ego Depletion

People have a limited supply of willpower, and it decreases with overuse

Willpower draws down mental energy - it's a muscle that can be exercised to exhaustion

For example, a research showed that people who initially resisted the temptation of chocolates were subsequently less able to persist on a difficult and frustrating puzzle task

Additionally, when people gave a speech that included beliefs contrary to their own, they were also less able to persist on the difficult puzzle

Elimination By Aspects

A decision-making technique

When people face with multiple options, they first identify a single feature that is most important to them

When an item fails to meet the criteria they have established, they cross the item off their list of options

Different features are applied until a single best option is left

For example, a consumer may first compare cars on the basis of safety, then fuel mileage, price, style, etc, until only one option remains

Endowment Effect

Once people own something (or have a feeling of ownership) they irrationally overvalue it, regarding of its objective value

People feel the pain of loss twice as strongly as they feel pleasure at an equal gain, and they fall in love with what they already have and prepare to pay more to retain it

For example, scientists randomly divided participants into buyers and sellers and gave the sellers coffee mugs as gifts

Then they asked the sellers for how much they would sell the mug and asked the buyers for how much they would buy it

Results showed that the sellers placed a significantly higher value on the mugs than the buyers did

Fear Of Missing Out (FOMO)

An anxious feeling that can happen when you fear that other people might be having rewarding experiences that you're missing

Many people have been preoccupied with the idea that someone, somewhere, is having a better time, making more money, and leading a more exciting life

According to science, FOMO is associated with lower mood, lower life satisfaction, and an increasing need to check social media

Framing Effect

A cognitive bias, in which people react to a particular choice in different ways depending on how it is presented, as a loss or as a gain

People tend to avoid risk when a positive frame is presented but seek risks when a negative frame is presented

For example, people are more likely to enjoy meat labeled 75% lean meat as opposed to 25% fat, or use condoms advertised as being 95% effective as opposed to having a 5% risk of failure

Gambler's Fallacy (Monte Carlo Fallacy)

The mistaken belief that, if something happens more frequently than normal during a certain period, it will happen less frequently in the future, or that, if something happens less frequently than normal during a certain period, it will happen more frequently in the future

For example, if you are playing roulette and the last four spins of the wheel have led to the ball's landing on black, you may think that the next ball is more likely than otherwise to land on red

In 1913 at the Monte Carlo Casino, the ball fell on the black of the roulette wheel 26 times in a row and gamblers lost millions betting against the black, thinking mistakenly that the next ball is more likely to land on red, when in fact the odds are the same as they always were - 50:50

Habit

A routine or behavior that is repeated and tends to occur subconsciously

Habits are performed automatically because they have been performed frequently in the past

Changing a habit is a process, not an event

According to science, it takes 66 days to form or change a new habit (and not 21 days like the old myth)

Halo Effect

A cognitive bias in which our overall impression of a person influences how we feel and think about his or her character

We assume that because people are good at doing A, they will be good at doing B and C too

Your overall impression of a person ("She is nice!") impacts your evaluation of that person's specific traits ("She is also smart!")

Scientists also found that people tend to rate attractive individuals more favorably for their personality traits or characteristics than those who are less attractive

Hedonic Adaptation

People quickly return to their original level of happiness, despite major positive or negative events or life changes

When good things happen, we feel positive emotions but they don't usually last

The excitement of purchasing a new car or getting a promotion at work is temporary

One study showed that despite initial euphoria, lottery winners were no happier than non-winners eighteen months later

Herd Behaviour

The tendency for individuals to mimic the actions (rational or irrational) of a larger group Individually, however, most people would not necessarily make the same choice

For example, in the late 1990s investors were investing huge amounts of money into Internet-related companies, even though most of them did not have structured business models

Their driving force was the reassurance they got from seeing so many others do the same

Hindsight Bias

(Knew-It-All-Along Effect)

The tendency of people to overestimate their ability to have predicted an outcome that could not possibly have been predicted

A psychological phenomenon is which people believe that an event was more predictable than it actually was, and can result in an oversimplification in cause and effect

For example, after the great recession of 2007, many analysts explained that all the signs of the financial bubble were there

If the signs had been that obvious, how come almost no one saw it coming in real time?

Hot-Cold Empathy Gap

We have trouble imagining how we would feel in other people's shoes

We are also not good at imaging how other people would respond to things because we assume they would respond in the same way we would

For example, people post videos of their kids or bragging about their latest business success on Facebook assuming that their friends would appreciate it and be happy for them

Unfortunately, this often provokes negative feelings and makes their facebook friends resentful, angry or sad

IKEA Effect

A cognitive bias in which people place a disproportionately high value on products they partially created

For example, in one study, participants who built a simple IKEA storage box themselves were willing to pay much more for the box than a group of participants who merely inspected a fully built box

Less Is Better Effect

When low-value options are valued more highly than high-value options

This effect occurs only when the options are evaluated separately

This way the evaluations of objects are influenced by attributes which are easy to evaluate rather those which are important

For example, a research revealed that a person giving an expensive £45 scarf as a gift was perceived to be more generous than one giving a £55 cheap coat

An overfilled ice cream serving in a small cup with 7 oz of ice cream was valued more than an underfilled serving in a large cup with 8 oz of ice cream

Licensing Effect

When people allow themselves to indulge after doing something positive first

Drinking a diet coke with a cheeseburger can lead one to subconsciously discount the negative attributes of the meal's high caloric and cholesterol content

Going to the gym can lead us to ride the elevator to the second floor

A study showed that people who took multivitamin pills were more prone to subsequently engage in unhealthy activities

Loss Aversion

People's tendency to prefer avoiding losses to acquiring equivalent gains

It's better not to lose £5 than to find £5

The pain of losing is psychologically about twice as powerful as the pleasure of gaining

For example, scientists randomly divided participants into buyers and sellers and gave the sellers coffee mugs as a gift

They then asked the sellers for how much they would sell the mug and asked the buyers for how much they would buy it

Results showed that the sellers placed a significantly higher value on the mugs than the buyers did Loss aversion was the cause of that contradiction

Mental Accounting

The tendency of people to divide their money into separate accounts based on subjective criteria, like the source of the money and the intent for each account

For example, people often have a special fund set aside for a vacation, while carrying substantial credit card debt, despite the fact that diverting funds from debt repayment increases interest payments and reduces net worth

Similarity, another study revealed that supermarket shoppers spent less money paying with cash than with credit cards

Comparing the price of goods to a smaller mental account (cash) than to a larger mental account (credit card) increased the pain of payment

Naive Diversification

When people have to make several choices at once, they tend to diversify more than when making the same time of decision sequentially

For example, when people ask to choose now which of six snacks to consume in the next three weeks, they pick more kinds of snacks than when they ask to choose once a week six snacks to consume that week for three weeks

As a result, investors tend to think that by simply investing in a number of unrelated assets, a portfolio will acquire enough diversification to enjoy relative freedom from high risk and potential for profit

Optimism Bias

A cognitive bias that causes people to believe that they are at a lesser risk of experiencing a negative event compared to others

When it comes to predicting what will happen to us tomorrow, next week, or fifty years from now, we overestimate the likelihood of positive events

For example, smokers tend to feel they are less likely than other individuals who smoke to be afflicted with lung cancer

Similarity, motorists tend to feel they are less likely to be involved in a car accident than is the average driver

Research has also found that people show less optimistic bias when experiencing a negative mood, and vice versa

Overconfidence Effect

We systematically overestimate our knowledge and our ability to predict

Overconfidence measures the difference between what people really know and what they think they know

It turns out the experts suffer even more from the overconfidence effect than laypeople do

Studies have found that over 90% of US drivers rate themselves above average, 68% of professors consider themselves in the top 25 percent for teaching ability, and 84% of Frenchmen believe they are above-average lovers

Overjustification Effect

The loss of motivation and interest as a result of receiving an excessive external reward (such as money and prizes)

When being rewarded for doing something actually diminishes intrinsic motivation to perform that action

For example, researchers gave children reward for doing activities they already enjoyed, like solving puzzles

Then, the children were given an opportunity to engage in these same activities on their own, when no rewards would be forthcoming

The results: children engaged in these activities less often than they did before

Pain Of Paying

Some purchases are more painful than others, and people try to avoid those types of purchases

Even if the actual cost is the same, there is a difference in the pain of paying depending of the mode of payment

Purchases are not just affected by the price, utility and opportunity cost, but by the pain of paying attached to the transactions

Studies show that people feel the pain of paying the most when they:

Paying in cash (as opposed to credit card)

Paying a separate fee/commission (as opposed to fee included in the total purchase price)

Paying as they consume (as opposed to one-time payment)

Paying frequently (as opposed to prepaid)

Paying on their own (as opposed to receiving a gift from their partners)

Partitioning

When the rate of consumption is decreased by physically partitioning resources into smaller units

For example, cookies wrapped individually, a household budget divided into categories eg rent, food, etc

When a resource is divided into smaller units, consumers encounter additional decision points - a psychological hurdle encouraging them to stop and think

Peak-End Rule

People judge an experience largely based on how they felt at its peak (the most intense point) and its end, rather than on the total sum or average of every moment of the experience

The effect occurs regardless of whether the experience is pleasant or unpleasant and how long the experience lasted

In a research, participants engaged with two experiences: short and long trial

In the short trial, they soaked their hands in water at 14°C for 60s

In the long trial, the same participants soaked their hands in water at 14°C for 60s and kept their hands under the water for extra 30s at 15°C

When the researchers asked the participants to choose which trial to repeat, the majority chose the long trial

Similarity, a study showed that in uncomfortable colonoscopy procedures, patients evaluated the discomfort of the experience based on the pain at the worst peak and the final ending moments

This occurred regardless of the procedure length or the pain intensity

Time Discounting / Present Bias

The tendency of people to want things now rather than later, as the desired result in the future is perceived as less valuable than one in the present

When offered a choice of £100 today (SSR - smaller sooner reward) and £100 in one month, people will most likely choose the £100 now

However, if offered a choice of £100 today (SSR) and £1000 in one month (LLR - larger later reward), people will most likely choose the £1000

The challenge is to find the point where people value the SSR and the LLR as being equivalent

For example, a research found that a £68 payment right now is just as attractive as a £100 payment in 12 months

Priming

When people are exposed to one stimulus, it affects how they respond to another stimulus

Their unconscious brain is affected by stimulus like colors, words or smells, which created an emotion that will affect their next actions

For example, one study revealed that when restaurants played French music, diners ordered more wine

In a different study, when websites' visitors were exposed to a green background with pennies on it, they looked at the price information longer than other visitors

Procrastination

The avoidance of doing a task that needs to be accomplished

It is the practice of doing more pleasurable things in place of less pleasurable ones or carrying out less urgent tasks instead of more urgent ones

It is estimated that 90% of college students engage in procrastination, and 75% consider themselves procrastinators

Projection Bias

The tendency of people to overestimate the degree to which other people agree with them

People tend to assume that others think, feel, believe, and behave much like they do

This bias also influences people's assumptions of their future selves They tend to believe that they will think, feel, and act the same in the future as they do now

For this reason, we sometimes make decisions that satisfy current desires, instead of pursuing things that will serve our long-term goals

For example, if people go to the supermarket when they are hungry - they tend to buy things they don't normally eat and spend more money as a result

This happens because at the time of shopping they unconsciously anticipate that their future hunger will be great as it is now

Ratio Bias

People's difficulties in dealing with proportions or ratios as opposed to absolute numbers

In a study, participants rated cancer as riskier when it was described as killing 1,286 out of 10,000 people than as killing 24.14 out of 100 people

The fact that 12.86% could be considered riskier than 24.14% is a clear demonstration that the ratio bias can strongly influence the perception of risk

In a similar study, participants rated the statement "36,500 people die from cancer every year" as riskier than the statement "100 people die from cancer every day"

Reciprocity

If someone does something for you, you'll naturally want to do something for them

When you offer something for free, people feel a sense of indebtedness towards you

For example, researchers tested how reciprocity can increase restaurant tipping

Tips went up to 3% when diners were given an after-dinner mint

Tips went up to 20% if, while delivering the mint, the waiter paused, looked the customers in the eye, and then gave them a second mint while telling them the mint was especially for them

In another study, 11% of people were willing to donate an amount worth one day's salary when they were given a small gift of candy while being asked for a donation, compared to 5% of those that were just asked for the donation

Regret Aversion

People anticipate regret if they made a wrong choice, and take this anticipation into consideration when making new decisions

Fear of regret can play a large role in dissuading or motivating someone to do something

For example, an investor decides to buy a stock based on a friend's recommendation

After a while, the stock falls by 50% and the investor sells the stock at lost

To avoid this regret in the future, the investor will research any stocks that his friend recommends

On the other hand, if the investor didn't take his friend recommendation and the price increased by 50%, next time the investor would be less risk averse and would buy any stocks his friend recommends

Representativeness Heuristic

People tend to judge the probability of an event by finding a comparable known event and assuming that the probabilities will be similar

When people rely on representativeness to make judgments, they are likely to judge wrongly because the fact that something is more representative does not actually make it more likely

For example, in series of 10 coin tosses, most people judge the series HTHTTTHHTH to be more likely than the series HHHHHHHHHH

In business, if a customer meets a salesman from a certain company that is aggressive, the customer might assume that the company has an aggressive culture

In finance, investors might prefer to buy a stock based on the company's positive characteristics (eg high-quality products) as an indicator for a good investment

Scarcity

The more difficult it is to acquire an item the more value that item has

When there is only a limited number of items available

The rarer the opportunity, the more valuable it is

People assume that things that are difficult to obtain are usually better than those that are easily available

They link availability to quality

On Black Friday, more than getting a bargain on a hot item, shoppers thrive on the competition itself, in obtaining the scarce product

In a famous study, one group of participants were given a jar with ten cookies, a second group was given two cookies, and a third group was initially given ten cookies, which were then reduced to two cookies when asked the participants to rate their cookies, the third group rated their cookies the highest

Social Proof

A psychological phenomenon where people reference the behavior of others to guide their own behavior

Studies show that over 70% of people say they look at product reviews before making a purchase and 83% of consumers say they trust recommendations over any other form of advertising

There are five types of social proof for your product or service:

1st
Experts Social Proof

An approval from credible industry leaders

If people buy something that they're unfamiliar with, they tend to rely on expert's opinion

2nd
Celebrity Social Proof

An approval or an endorsement from celebrities

Celebrities are walking advertisements, so any product or service that they recommend or are seen using are bound to get a lot more attention

3rd
User Social Proof

An approval from current customers/users of a product or service

This includes customer testimonials, case studies, and product/service reviews

4th
Wisdom of the Crowd

An approval from a large group of people

When lots of people are using or buying a product, others want to follow

5th
Wisdom of Friends

An approval from friends and people you know

92% of consumers trust recommendations from people they know and pay 2X more attention to recommendations from friends

Sunk Cost Fallacy

The tendency of people to irrationally follow through on an activity that is not meeting their expectations because of the time and/or money they have already spent on it

The logic form

X has already been invested in project Y

Z more investment would be needed to complete project Y, otherwise X will be lost

Therefore, Z is justified

The sunk cost fallacy explains why people finish movies they aren't enjoying, finish meals in restaurants even though they are full, hold on to investments that are underperforming and keep clothes in their closet that they've never worn

Zero Price Effect

When any item priced at exactly zero will not only be perceived to have a lower cost but will also be attributed greater perceived value

When people are offered something for free, they have an extremely positive reaction that clouds their judgment

In an experiment, one group of participants were given three choices

Buy a "low-value product" (a Hershey's Kiss) for one cent, buy a "high-value product" (a Lindt truffle) for 14 cents, or buy nothing

The second group faced a slightly different choice, in which the cost of each chocolate was lowered by a single cent

The Lindt truffle was now 13 cents, while the Hershey's Kiss was free

The results showed that when both chocolates are not free, the majority preferred the higher value product

But when the lower value product was offered free, the majority of people preferred it