5. Behavioral Economics

Behavioural economics is an approach to economics which takes into account human behavior. In his book “Thinking fast and slow”, which is based on the work he did with Tversky, Kahneman describes human thought as being divided into two systems i.e. System 1 which is fast, intuitive and emotional, and System 2, which is slow, rational and calculating. He further described these systems as being the basis for human reasoning, or the lack thereof, and the impact of these on the markets. Some of the findings are the inability of human beings to think statistically, called heuristics and biases, the concept of Anchoring, Availability effect, Substituting effect, Optimism and Loss aversion effect, Framing effect, Sunk costs and Prospect theory where a reference point is important in evaluating choices rather than economic utility. With the advent of decision making using intelligent machines, all these effects and biases are eliminated. System 1, which is intuitive, is eliminated altogether. System 2 becomes the norm, as advances in artificial intelligence are made. System 2 becomes fast because contemporary computational intelligent machines work fast. If one considers Moore’s Law, which states that computational power doubles every year, System 2 next year is faster than System 2 this year, thus making machines “Think Fast and Faster”.