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Biases and Heuristics

Meet the mental shortcuts that systematically skew decisions.

  • Define and explain Biases and Heuristics in your own words
  • Use key terms such as bounded rationality accurately
  • Apply what you have learned to new examples and questions
  • Avoid the common mistakes learners make with this topic

This lesson focuses on Biases and Heuristics: meet the mental shortcuts that systematically skew decisions.

Definition: Biases and Heuristics

Meet the mental shortcuts that systematically skew decisions.

Key ideas

Heuristics and biases

Mental shortcuts save effort but cause systematic errors. Anchoring makes the first number we see disproportionately influential; availability bias makes dramatic events feel more likely than they are; present bias makes us overvalue immediate rewards and under-save for retirement.

From homo economicus to real humans

Neoclassical theory models people as rational utility-maximisers with stable preferences. Behavioural economists show decisions are shaped by framing, emotions and social norms: the same product described as '90% fat-free' versus '10% fat' gets very different responses.

Key term — bounded rationality: Herbert Simon's idea that rationality is limited by information, time and mental capacity, so people 'satisfice' (settle for good enough) rather than optimise.

Worked example: Biases and Heuristics

What is bounded rationality?

The idea that people's rationality is limited by information, time and mental capacity, so they satisfice rather than optimise.

Answer: The idea that people's rationality is limited by information, time and mental capacity, so they satisfice rather than optimise.

Common mistakes
  • Calling every error 'irrational' Behavioural biases are systematic and predictable — that is precisely why they can be modelled and nudged, unlike random errors.
  • Thinking nudges remove freedom A true nudge preserves choice — banning an option is a mandate, not a nudge.

Practice

Explain loss aversion in one sentence.
Losses vs gains.

Losses hurt roughly twice as much as equivalent gains please, so people avoid risks involving losses.

A shop labels mince '90% fat-free' rather than '10% fat'. Which bias does this exploit?
Think about presentation.

Framing — the same information presented positively changes choices.

Why did auto-enrolment raise pension saving?
Think about defaults.

Inertia/status-quo bias: most workers stick with the default of being enrolled rather than opting out.

Give one criticism of nudge theory.
Think about manipulation.

Any one of: it can be manipulative; it may not address root causes; effects may not transfer across contexts.

Quick check

Biases and Heuristics — quick check

Which of these best defines "bounded rationality"?

Herbert Simon's idea that rationality is limited by information, time and mental capacity, so people 'satisfice' (settle for good enough) rather than optimise.

What is present bias, and how does it affect saving?

Overvaluing immediate rewards relative to future ones, so people spend now and under-save for retirement.
Key takeaways
  • Biases and Heuristics: meet the mental shortcuts that systematically skew decisions.
  • Heuristics and biases: Mental shortcuts save effort but cause systematic errors.
  • anchoring: Relying too heavily on the first piece of information encountered, such as an initial price, when making decisions.
  • Watch out for: calling every error 'irrational'
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