With the "older" understanding of economic theory, it was believed that people made rational decisions. But psychologist have shown that people are not rational. Psychology turned economic theory upside down. As decision making was studied it became apparent that people use the general principle of the availability heuristic which is that people make decisions by the thing that most readily comes to their mind. Generally, it is something that has been recently heard or seen and is therefore readily available in the memory to make a general judgement about something. This works very well in advertising but it works for about everything. Now place this with priming or prompts (ideas placed to activate an association in our memory) and you can see what a powerful tool this can be.
The prospect theory is that losing hurts more than winning feels good. Game theory comes into play with the prospect theory, which people are willing to gamble to avoid a loss. If markets start to go down people will hang on but when the markets are high people will then sell. Implications can be taken that at a policy level it may become necessary to keep people from hurting themselves, if they are a threat to themselves the law can come in to protect them. In economics, policies can be implimented that make people make good decisions. Some might even call this a form of social engineering and some liberal economists are very much for this. Dick Bailer has just written a book called Nudge, he is a behavioral psychologist.
Thus, the notion is that we, the people, do not make good, rational consumers and this may lead to more theories on judgement and economics and policies to help us out.
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