What is Behavioural Economics?
Understanding decision making
Behavioural economics uses psychology to analyse the decision-making behind an economic outcome. This applies to everyday consumer choices such as what we buy for our lunch through to more complex considerations like retirement planning.
The concept can be applied to individual and group decisions and more broadly to encompass the wider actions of a society or trends in market sectors.
The rational choice
Classical economics views economic decision making as a logical process taken by rational individuals. It tends to take place in an environment of perfect information and the results can be recorded on a graph. When we do not behave that way, which is often, the maths becomes rather challenging.
Behavioural economics provides a framework to make sense of our irrationality and can be used to create stimuli to nudge people towards better decisions.
Behavioural economics shows that human beings do not always act in logical ways. Current context, self-control, cognitive abilities and immediate satisfaction are strong factors in decision making and lead us to act in an irrational manner. Behavioural economics traces these decision errors to the design of the human mind and attempts to integrate a psychological understanding of human behaviour into economic analysis. There are three key theories that behavioural economists use to understand consumer behaviour:
- Heuristics: 95% of decisions are made using mental shortcuts or rules of thumb.
- Framing: The anecdotes and stereotypes that individuals rely on to understand and respond to events.
- Market inefficiencies: These include mis-pricing and non-rational decision making.
With an understanding of why people act in a certain way behavioural economics can suggest ways in which businesses, organisations and governments can make changes to prompt different choices using nudge theory. For example, simply rearranging items offered within the school dining room encourages children to buy more nutritious items (e.g., placing the fruit at eye level, making choices less convenient by moving soda machines into more distant areas, or requiring students to pay cash for desserts and soft drinks).
Noble prize winning science
The profile of behavioural economics gained considerable traction in 2017 when the US academic Richard Thaler won the Nobel Prize in economics for his pioneering work in this field. The Royal Swedish Academy of Sciences praised Thaler for incorporating psychological assumptions into analyses of economic decision-making. In 2002, psychologist Daniel Kahneman was awarded the Nobel Memorial Prize in Economic Sciences “for having integrated insights from psychological research into economic science” and in 2013, economist Robert J. Shiller received the same prize for “for his empirical analysis of asset prices.”