Behavioral Economics - First Entry

The first car

    When a young person buys their first car, they rarely think in terms of net present value or long-term financial planning. Instead, the car is seen as a symbol of independence, status, and freedom. It represents adulthood, mobility, and social recognition. Because of this strong emotional meaning, several biases studied in Behavioral Economics become especially powerful in my opinion. These biases can slowly push young people toward decisions that increase the risk of over-indebtedness, even if they do not realize it.

First, loss aversion helps explain this behavior within Prospect Theory. Young people evaluate the decision relative to a reference point, such as “having a car like my friends” or “being independent.” Not reaching this point feels like a loss, and losses weigh more than gains. As a result, the psychological pain of waiting or “missing out” can feel stronger than the financial cost of a long and expensive loan.

Second, present bias strongly influences the decision. Present bias means that people give too much weight to immediate rewards and too little weight to future costs. Buying a new car produces a large and immediate satisfaction: going to the dealership, driving the car for the first time, showing it to friends. In contrast, the costs are spread over many months or even years. Monthly payments, insurance, fuel, taxes, and maintenance feel distant and abstract. Because of present bias, a young buyer may focus on the idea that the car costs “only 250 euros per month” and ignore the total cost of the loan over five or seven years. The future sacrifices are heavily discounted in the mind.

Another important mechanism is mental accounting. Instead of evaluating the car within the total personal budget, the buyer creates a separate “mental account” for the car payment. As long as the monthly payment seems manageable inside that account, the decision feels reasonable. This way of thinking makes it easier to accept additional options, extended warranties, or service packages. All these extras are included in the same payment, so they do not feel like separate costs. In reality, they increase the total debt.

Overconfidence is also relevant. Many young people are optimistic about their future income. They believe they will soon find a better job, finish their studies, or receive higher salaries. This optimism can lead them to underestimate the probability of unemployment, temporary contracts, or unexpected expenses. Because of overconfidence, they may commit to a high level of debt compared to their current income. If their expectations about the future are too optimistic, the financial burden can become difficult to manage.

Closely related is projection bias, which means that people assume their current preferences and situation will remain stable in the future. For example, a student who currently travels every weekend may believe that this lifestyle will continue for many years. However, life circumstances often change: moving to another city, changing jobs, or having different priorities. By projecting today’s situation into the future, the buyer may justify paying more for features that will not be fully used.

As a result, all these biases make many young people end up allocating a large share of their income to a depreciating asset, leaving them with less room for savings, emergencies, or investment, which in the long term has negative financial consequences.

Alejandro Olivares Rodríguez