Behavioral Economics Essay Example | Topics and Well Written Essays - 2500 words

Behavioral Economics - Essay Example Generally beliefs concerning the uncertain events are expressed by statements like "I think thator chances are etc. These are sometimes expressed in numerical form as odd or subjective probabilities. Heuristics are simple, efficient rules, fine-tuned by evolutionary processes or learned, which have been proposed to explain how people make decisions, judgments and solve problems, typically when facing serious problems or in case of inadequate information (Tversky, Kahneman,1124). People often follow a limited number of heuristic principles in day-to-day life, which reduces the process of assessing values and probabilities to much more simple judgmental operations. These heuristics are very useful but at times can leads to severe and systematic errors (Tversky, Kahneman, 1124). In case of representative heuristics (Tversky and Kahneman, 1126), the likelihood of an event is judged based upon the extent to which it represents the essential features of the parent population or the generating process. Representative heuristic is generally used by people to make judgment or impression about someone or something. (Koning, 1) It is usually employed while deciding the probability whether or not an object or event A belongs to class or process B. (Tversky and Kahneman, 1131) For illustration of representative heurist... he example of Steve who has been described by his neighbor as "very shy and withdrawn, invariably helpful but with little interest in people or in world of reality. A meek and tidy soul, he has a need for order and structure and a passion for detail. How are people going to judge the possible occupation of Steve from a list of possibilities (e.g. farmer, salesman, librarian, airline pilot or physician) In the representative heuristic, the probability of is assessed by the degree to which he is representative of, or similar to, in this case say a librarian, the stereotype of a librarian. Research with similar type of problems shows that probability and similarity plays equal important role in case of occupation of people. This method of arriving at a particular decision based on the similarity or the representativeness leads to erroneous results affecting the ultimate outcome because similarity is not influenced by the factors which influence judgment probability (Tversky and Kahneman , 1131). There are some drawbacks of representative heuristic which can be rectified by considering the following parameters. Insensitivity to prior probability of outcomes (Base-rate neglect): The base rate fallacy, also called base rate neglect, is an error that occurs when the conditional probability of some hypothesis given some evidence is assessed without taking sufficient account of the "base rate" or "prior probability" of hypothesis (Wikipedia). The prior probability or base-rate frequency of the final decision has a great deal of effect on the probability. In the above example, the fact that there are many more farmers than librarians in the population should be considered while judging, for an estimation of probability that Steve is a librarian rather than a farmer. People tend