How do prospect theory and bounded rationality challenge the assumptions of classical economic models, and what insights do they offer into human decision-making under uncertainty and risk? Furthermore, how can these insights be applied to design more effective policies and interventions?

Prospect theory suggests that individuals’ decisions are influenced by subjective perceptions of gains and losses rather than objective outcomes, leading to deviations from rational decision-making predicted by classical economics. Bounded rationality acknowledges cognitive limitations and heuristics used by individuals when making decisions. Understanding these behavioral biases can inform the design of nudges, incentives, and policies to promote better decision-making in areas such as savings, health behavior, and environmental conservation.