Psychology and economics are two very different subjects, but they have a lot of things in common among them. Psychology and economics is the study of behaviors that tend to influence the behaviors of individuals, how they tend to make certain financial decisions, how they tend to spend their money, and how they tend to purchase items as well as stock. This field tends to combine various human cognitions, emotions, insights, biases, and their impact, economic behavior, and outcomes. There are various psychological aspects of economics which are talked about below.
Cognitive biases and heuristics i.e. the shortcuts which have been used by an individual tend to influence the economic decisions which have been taken by the individual. It has been found that overconfidence as well as the disposition effect tend to affect such professionals (Kumar S., & Goyal N., 2015). Mostly, the investors while investing money into the stock market or into some company tend to be overconfident while making predictions about the growth, profits, and losses generated (Berthet V., 2002). It was also found in various surveys that some people tend to take more risks and invest more money as a result of this overconfidence (Chuang W.I., & Lee B.S., 2006). The disposition effect is an effect where the investor holds to the losing position of money for a long period of time and sells off the winning position in a short period of time (Sheffrin H., & Statman M., 1985). Officially, there is no explanation for this particular effect, but some studies have shown a combination of prospect theory, which was proposed by Kahnemann and Tversky as well as mental accounting (Summers B., & Duxbury D., 2012).
Prospect theory which was given by Kahnemann and Tversky talks about choosing among options that themselves rest on biased judgements. This theory plays an important role by being the foundational role in economic psychology. It plays an important role in predicting the traditional economic models and the impact of different psychological factors on the decision-making abilities of an individual. This theory builds upon these insights and helps understand how different individuals are able to make economic choices (Kahneman D., & Tversky A., 1979).
Behavioral economics is also an important aspect of the relationship that exists between economics and psychology. It is used to study irrational consumer choices as well as the difference between them and the rational consumer choices that have been made. It frames and talks about different theories which mainly focus on helping people gain more and experience less amounts of losses. Behavioral economics is also used to explain various kinds of market dynamics, like market losses, herding behavior, overconfidence, stock market bubble formation, etc. along with the psychological aspect of it. It also helps people make wise choices regarding where to invest and how to invest in some particular company’s stocks or how to diversify the stock market portfolio of an individual (Barberis N., Shleifer A., & Vishny R., 1998). Nudge theory is an aspect of behavioral economics that talks about the concept of “nudging” which in turn is derived from behavioral economics. It talks about maintaining one’s own personal freedom and at the same time structuring choices in such a way that we are able to make decisions that are in our best interest (Thaler R.H., & Sunsten C.H., 2008).
In conclusion, economic psychology talks about different ways through which one’s ability to make decisions about their own finances is affected. This can be seen from the scale of one single individual to entire governments.
References-
Berthet V., (2021).The Impact of Cognitive Biases on Professionals’ Decision-Making: A Review of Four Occupational Areas. Front. Psychol., 04 January 2022
Sec. Personality and Social Psychology. Volume 12 - 2021 https://doi.org/10.3389/fpsyg.2021.802439
Kumar, S., and Goyal, N. (2015). Behavioural biases in investment decision making – A systematic literature review. Qual. Res. Financ. Markets 7, 88–108. doi:
10.1108/QRFM-07-2014-0022
Chuang, W.-I., and Lee, B.-S. (2006). An empirical evaluation of the overconfidence hypothesis. J. Bank. Financ. 30, 2489–2515. doi: 10.1016/j.jbankfin.2005.08.007
Shefrin, H., and Statman, M. (1985). The disposition to sell winners too early and ride losers too long: theory and evidence. J. Financ. 40, 777–790. doi: 10.1111/j.1540-6261.1985.tb05002.x
Summers, B., and Duxbury, D. (2012). Decision-dependent emotions and behavioral anomalies. Organ. Behav. Hum. Decis. Process. 118, 226–238. doi: 10.1016/j.obhdp.2012.03.004
Kahneman, D., & Tversky, A. (1979). "Prospect Theory: An Analysis of Decision under Risk." Econometrica, 47(2), 263-291.
Barberis, N., Shleifer, A., & Vishny, R. (1998). "A Model of Investor Sentiment." Journal of Financial Economics, 49(3), 307-343.
Thaler, R. H., & Sunstein, C. R. (2008). "Nudge: Improving Decisions About Health, Wealth, and Happiness." Yale University Press.
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