Behavioural Economics and Household Financial Decision-Making: Impacts on Household Welfare and Economic Stability

Abstract

Household financial decision-making plays a critical role in determining both individual welfare and broader economic stability. Traditional economic theories assume that individuals make rational financial decisions; however, behavioural economics demonstrates that cognitive biases and psychological heuristics frequently influence financial choices. This study investigates the impact of behavioural economics on household financial decision-making and examines how cognitive biases affect household welfare and economic stability. Specifically, the research focuses on four major behavioural constructs: loss aversion, present bias, risk perception, and mental accounting.

A sequential explanatory mixed-methods research design was adopted, integrating quantitative, experimental, and qualitative approaches. Primary data were collected from 1,248 households across Punjab, Sindh, and Khyber Pakhtunkhwa using structured questionnaires, behavioural experiments, and semi-structured interviews. Quantitative data were analysed using descriptive statistics, Partial Least Squares Structural Equation Modelling (PLS-SEM), probit regression, mediation analysis, and experimental analysis, while qualitative data were analysed through thematic analysis to provide deeper insights into household financial behaviour.

The findings reveal that behavioural biases significantly influence household financial decisions. Loss aversion and present bias were found to have significant negative effects on household financial welfare and participation in formal financial services, whereas mental accounting demonstrated a modest positive association with financial outcomes. Risk perception was identified as a significant mediating factor between behavioural biases and financial welfare, while financial literacy moderated the adverse effects of cognitive biases. Experimental findings further confirmed that framing effects significantly influence investment decisions and risk-taking behaviour. The study concludes that behavioural factors should be integrated into financial policy design, financial education programmes, and consumer protection strategies to improve household financial outcomes and promote long-term economic stability.

The research contributes to the growing literature on behavioural household finance by providing empirical evidence from Pakistan, highlighting the importance of incorporating psychological dimensions into financial decision-making models and public policy interventions.

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