Understanding Behavioral Economics: Theories, Goals, and Real-World Applications

By

Will Kenton April 23, 2026

Behavioral economics is the study of psychology as it relates to the economic decision-making processes of individuals and institutions. It draws on psychology and economics to explore why people sometimes make irrational decisions, and the cognitive biases that cause behavior to diverge from economic models.

Behavioral economics is particularly useful in marketing strategies to predict consumer behavior. Behavioral economics is often related with normative economics.

Exploring the Principles of Behavioral Economics

In an ideal world, people would always make optimal decisions that provide them with the greatest benefit and satisfaction. In economics, rational choice theory states that when humans are presented with various options under the conditions of scarcity, they would choose the option that maximizes their individual satisfaction.

This theory assumes that people, given their preferences and constraints, are capable of making rational decisions by effectively weighing the costs and benefits of each option available to them. The final decision made will be the best choice for the individual. The rational person has self-control and is unmoved by emotions and external factors and, hence, knows what is best for himself. Alas, behavioral economics explains that humans are not rational and are incapable of making good decisions.

Because humans are emotional and easily distracted beings, they make decisions that are not in their self-interest. For example, according to the rational choice theory, if Charles wants to lose weight and is equipped with information about the number of calories available in each edible product, he will opt only for food products with minimal calories.

Behavioral economics states that even if Charles wants to lose weight and sets his mind on eating healthy food going forward, his end behavior will be subject to cognitive bias, emotions, and social influences. If a commercial on TV advertises a brand of ice cream at an attractive price and quotes that all human beings need 2,000 calories a day to function effectively after all, the mouth-watering ice cream image, price, and seemingly valid statistics may lead Charles to fall into the sweet temptation and fall off of the weight loss bandwagon, showing his lack of self-control.

Key Factors Influencing Economic Behavior

There are often five factors that are cited when analyzing how individual behavior is influenced.

Bounded Rationality

Bounded rationality is the idea that individuals make decisions based on the knowledge they have. Unfortunately, this information is often limited, whether by the individual's lack of expertise of lack of available information. In regards to finance and investing, the same public information is available to everyone, though investors may not know true circumstances of what is happening with a company internally.

Choice Architecture

People can be easily manipulated, and this is often on display in the way promoters craft incentives or deals to make consumers buy certain products. Consider how a cracker display may be presented right next to the cheese aisle within a supermarket. This layout is designed to guide consumers into decisions using a planned display of related products.

Cognitive Bias

Whether people realize it or not, everybody makes decisions that are influenced by cognitive bias. Consider the choice of choosing between two companies to invest in. Behavioral economics holds the theory that the color of the logo, the name of the CEO, or the city in which each company is headquartered in may stir up an unknown bias that yields us to choose the other company.

Discrimination

In a similar light, behavioral economics is often associated with discrimination. People perceive things, events, or other people through their own lenses, potentially discriminating towards others because they simply favor a different alternative. This does not necessarily mean the alternative is a better option, though.

Herd Mentality

Many consumer decisions are influenced by what other people are doing. Whether it is the fear of missing out or whether others want to be part of a larger collective, herd mentality is the belief that individual decisions are swayed based on what other people do, not necessarily on what is the best outcome. After all, it is much easier rooting for your favorite team even if they haven't won a championship in a while as long as other fans share your pain.

Fast Fact

The media plays a critical part in behavioral economics. Consider how a single headline can grab your attention and make you want to either pursue or avoid a product.

Practical Applications of Behavioral Economics

Financial Markets

One field in which behavioral economics can be applied to is behavioral finance, which seeks to explain why investors make rash decisions when trading in the capital markets. Much like how poker professionals not only study the mathematics and odds of poker, they also attempt to capitalize on the irrational nature of other players. This concept also applies to financial markets.

Game Theory

When a decision made leads to error, heuristics can lead to cognitive bias. Behavioral game theory, an emergent class of game theory, can also be applied to behavioral economics as game theory runs experiments and analyzes people’s decisions to make irrational choices. This concept attempts to override illogical behavior to predict consumption outcomes.

Pricing Strategies

Companies are increasingly incorporating behavioral economics to increase sales of their products. In 2007, the price of the 8GB iPhone was introduced for $600 and quickly reduced to $400. By launching the phone at $600 and then reducing it to $400, consumers felt they got a deal, even if it was valued at $400.

Product Packaging and Distribution

Consider a soap manufacturer who produces the same soap but markets them in two different packages to appeal to multiple target groups. One package advertises the soap for all soap users, the other for consumers with sensitive skin. The latter target would not have purchased the product if the package did not specify that the soap was for sensitive skin. They opt for the soap with the sensitive skin label even though it’s the exact same product in the general package.

What Is the Goal of Behavioral Economics?

The goal of behavioral economics is to understand why humans make the decisions they do. There are usually outcomes that are the best for people and many times, people do not choose that outcome. Behavioral economics is an incredibly complex and sometimes inexplainable science of why people do things and why they choose to not be rational.

What Is the Difference Between Behavioral Economics and Psychology?

Both behavioral economics and psychology refer to the dispositions, emotions, and decision-making of individuals. Behavior economics is a much more niche field that studies the financial decision-making of an individual, while psychology may cover any aspect of human rationality.

What Is the Downside to Behavioral Economics?

One downside to behavioral economics is that it can be used to deceive or manipulate people and their decision-making. Though people are often not rational, this irrationality may be predictable. Companies can choose to exploit this by packaging their products in a certain way, pricing their goods at specific levels, or customizing their marketing to attract certain markets.

The Bottom Line

Behavioral economics is a field of study aimed at understanding why people make economically irrational decisions. It explores the role of psychological factors in economic decision-making. It contrast with rational choice theory, it acknowledges that cognitive biases and loss aversion can sometimes lead to non-optimal decisions.

Behavioral economics principles are particularly important in financial markets and public policy. Consumers should also be aware that their shopping habits could be manipulated by unethical companies.