Economic Psychology Report

Amanda Fraser - Head of Department

Economic Psychology – Why We Spend, Save, and Splurge

1. Introduction – What Is Societal and Economic Psychology?

Economic Psychology examines how psychological elements affect financial decision-making processes. The discipline investigates how psychological elements including  emotions together with mental shortcuts and risk assessment and cognitive distortions influence consumer and financial decision processes. Economic  psychology differs from classical economics because it recognizes that human choices about money result from fear alongside optimism and  habitual patterns and identity-based decision-making. The discipline integrates elements from psychology with behavioural economics and conventional  economic principles. People tend to save less than what would be beneficial yet researchers seek to understand this phenomenon.  People demonstrate a preference for immediate advantages even when these choices lead to less valuable long-term outcomes. People  experience stronger emotional reactions to losing something compared to their reactions to gaining something.

2. Case Studies

A. Loss Aversion in Stock Markets (Kahneman & Tversky)

In their famous Prospect Theory (1979), Kahneman and Tversky demonstrated that people fear losses more than they value gains of the same amount—known as loss aversion. This insight helps explain irrational stock market behaviours, like investors holding onto losing stocks too long or panic-selling during downturns. (JSTOR)

B. Credit Card Overspending and Mental Accounting (Richard Thaler)

Thaler’s research found that people treat money differently depending on how they mentally "label" it. For example, many spend more with credit cards than cash because the pain of paying is delayed. This "mental accounting" shows how spending decisions are not always rational but are influenced by how we perceive and compartmentalise finances (Journal of Economic Perspectives).

3. Defined Keywords

• Cognitive bias – Systematic errors in thinking that skew decisions
  
  

• Loss aversion – Tendency to prefer avoiding losses over equivalent gains
  
  

• Heuristics – Mental shortcuts or "rules of thumb"
  
  

• Anchoring – Relying too heavily on the first number or idea offered
  
  

• Mental accounting – Subjective categorisation of money
  
  

• Present bias – Preference for immediate gratification
  
  

• Status quo bias – Tendency to stick with current choices
  
  

• Endowment effect – Overvaluing what one owns
  
  

• Framing effect – How the same information, presented differently, alters perception

4. Conclusion

Economic Psychology studies the hidden psychological processes which influence financial human behavior in subtle ways. Through understanding  these behavioral patterns economists and policymakers create better decision-making strategies such as designing opt-in pension systems and placing healthy  foods at eye level. The study of economic psychology produces insights which enable both individuals to develop improved financial  habits and governments to create superior policies and just economic frameworks.

©Amanda Fraser- Econ Icon

Works Cited

Kahneman, Daniel, and Amos Tversky. “Prospect Theory: An Analysis of Decision under Risk.” Econometrica, vol. 47, no. 2, Mar. 1979, pp. 263–292, www.jstor.org/stable/1914185, https://doi.org/10.2307/1914185.

Thaler, Richard H. “Anomalies: Saving, Fungibility, and Mental Accounts.” Journal of Economic Perspectives, vol. 4, no. 1, Feb. 1990, pp. 193–205, https://doi.org/10.1257/jep.4.1.193.