An Introduction To Behavioral Economics Concepts

Behavioural economics combines psychology into the examination of decision-making that leads to an economic outcome, such as the variables that contribute to a customer purchasing one product over another.

A University of Chicago professor Richard Thaler, who just earned the Nobel Memorial Prize in Economic Sciences, has influenced researchers from several fields and significantly altered our understanding of human behaviour.

He is widely regarded as the founder of behavioural economics, a relatively young subject that combines ideas from judgement, psychology, as well as economics, and decision-making, to produce a more accurate understanding of human behaviour.

Behavioural economics, unlike classical economics, which relies solely on cold-headed reasoning to make decisions, allows for illogical behaviour, and seeks to explain why it occurs.

The idea can be applied to individual circumstances in a microcosm, or it can be used more widely to cover a society's behaviours or financial market patterns.

Humans make judgments that are not in their best interests because they are emotional and easily distracted.

As per the rational choice theory, if a man wants to lose weight and has information on the quantity of calories in each ingredient in food, he will choose only the meals with the fewest calories.

According to behavioural economics, even if the man wants to lose weight and commits to eating healthier foods in the future, his final behaviour will be influenced by cognitive bias, emotions, and social factors.

Brexit is an illustration of how behavioural economics may be beneficial. According to Thaler, the theory can assist explain how the close vote to leave the EU was driven by gut decisions rather than logical decision-making.

The idea is especially beneficial for businesses and marketers trying to improve sales by promoting changes in customer behaviour. It can also be used to establish public policy.

Thaler is well known for his work on “nudge theory,” a phrase he developed to describe how minor interventions may persuade people to make alternative choices.

Nudges, on the other hand, can be manipulative, to the disadvantage of individuals.

So here are a few nudge theory examples:

Supermarkets:

Thaler proposes that modifications to an individual's "choice environment" may be made to affect their behaviour. The supermarket is the finest illustration of this, as attention may be focused to certain items to entice people to spend money.

Donation of organs:

Thaler has investigated the role of inertia and the power of default arrangements in organ donation authorization.

In a proposal that was fundamental to her address at the Conservative Party Conference in Manchester, Theresa May is proposing a system of assumed consent, in which individuals are presumed to accept to the use of body parts after death unless they opt out.

Reminders about taxes:

The Whitehall nudge team assisted in rewriting tax reminder letters using behavioural economics concepts, which it claimed helped the government save more than £200 million in one year.

E-cigarettes:

The behavioural insights team collaborated with the Department of Health on the regulatory framework for e-cigarettes, seeing the devices as potentially helpful in aiding smokers in quitting. 

It told the administration that substituting a comparable behaviour is considerably easier than eliminating an established one. More than 2.3 million individuals vape today.

Application:

Heuristics, which is the use of rules of thumb or mental shortcuts to make a rapid choice, is one application of behavioural economics.

However, when a judgement is taken that results in a mistake, heuristics can lead to cognitive bias.

An emerging class of game theory, behavioural game theory, may also be used to behavioural economics since game theory performs experiments and examines people's decisions to make illogical choices.

Behavioural finance, which tries to explain why investors make hasty judgments when trading in the capital markets, is another sector in which behavioural economics may be used.

Companies are increasingly using behavioural economics to enhance product sales. Consider a soap producer who makes the same soap but sells it in two different packaging to appeal to distinct target audiences.

One packaging promotes the soap to all soap users, while the other caters to those with sensitive skin. If the box had not said that the soap was for sensitive skin, the latter target would not have purchased the product.

They choose the soap with the sensitive skin label, despite the fact that it is the identical product in the regular box.

As firms recognise that their customers are irrational, an effective approach to incorporate behavioural economics in the company's decision-making processes that affect its multiple stakeholders may become beneficial if done correctly.

Behavioural economics allows for illogical behaviour and seeks to explain why it occurs. The theory can help explain how Brexit vote was driven by gut decisions rather than logical decision-making.

The Whitehall nudge team helped rewrite tax reminder letters using behavioural economics concepts. Companies are increasingly using them to enhance product sales by targeting different audiences for different products.

 Written By - Tanya C