Definition
Behavioural Economics is a study field within economics that focuses on understanding how psychological, emotional, cognitive, or cultural factors influence the economic decisions made by individuals and institutions. This discipline looks at why people sometimes make irrational decisions and how they might deviate from the idealized economic models. It merges the elements of psychology and economics to explain human behaviour that traditional economics fails to explain.
Key Takeaways
- Behavioural economics integrates insights from psychology, judgement, decision making and economics to generate a more accurate understanding of human behaviour. It questions the traditional economic theory which assumes that individuals are rational and always aiming to maximise their utility.
- This field of study often focuses on the biases and heuristics (mental shortcuts) that humans use in decision-making processes, which often lead to irrational economic decisions. Examples of these are anchoring, where decisions are too heavily reliant on one piece of information, or loss aversion, where people prefer to avoid losses than acquire equivalent gains.
- Behavioural Economics has broad applications. It is used in both macro and micro-economics contexts, influencing policy-making, business strategies, and individual financial decision-making. By understanding behavioural economics, strategies can be better tailored to work with, rather than against, our inherent biases and mental habits to achieve desired outcomes.
Importance
Behavioural Economics is important because it offers valuable insights into the psychological aspects that influence decision-making process of individuals and institutions.
It challenges the traditional economic theory which assumes that all individuals are rational and always aim to maximize their benefit.
By understanding various cognitive biases, emotions, and social factors that actually influence human behavior, behavioural economics allows for more accurate predictions and explanations of economic phenomena.
This interdisciplinary, nuanced understanding of economic behaviour can thus lead to more effective policy-making, business strategies, and personal finance decisions.
Hence, the significance of behavioural economics extends from individual financial choices to shaping global economic policies.
Explanation
Behavioural economics is a valuable tool used primarily to better understand the complex choices that individuals make when dealing with matters related to their finances. It accounts for the psychological, cognitive, emotional, and cultural influences on economic decisions and explores why people sometimes make irrational decisions, allowing the decision-making process to be more accurately predicted.
Its purpose extends beyond mere understanding; the insights gained in behavioural economics can be leveraged by economists, policy makers, and businesses to shape and influence behavioural patterns favourably. Practical applications of behavioural economics are profoundly influential in various fields.
For example, policy makers can use the insights from behavioural economics to design interventions that guide people towards better decision-making, known as “nudges”. Businesses often use behavioural economics to bolster marketing strategies, setting pricing or promoting products in ways that appeal to consumer behaviour. Financial advisors can help clients overcome biases and make better investment decisions.
In essence, behavioural economics is used to understand, predict, and guide human behaviour within economic contexts for more effective outcomes.
Examples of Behavioural Economics
Retirement Savings: One of the most common examples of behavioural economics is seen in the retirement savings decisions individuals make. Many people tend to procrastinate or underestimate how much they need to save for their retirement. This is due to biases such as overconfidence and short-term bias (preferring immediate gains over long-term benefits). To combat this, many employers use automatic enrolment retirement plans to nudge employees to start saving early and consistently.
Marketing and Pricing Strategies: Businesses often use behavioural economics to influence consumer behaviour. An example of this can be seen in pricing strategies, such as setting the price of a product at $
99 instead of $
Even though the actual difference is just one cent, the perceived cost to the consumer is significantly lower. This is known as the left-digit effect.
Health Choices: Behavioural economics can also explain why people often make poor health choices, such as smoking, overeating, or not exercising. For instance, while people may know the health benefits of exercise and eating healthy, they might choose behaviours that provide immediate satisfaction, such as eating junk food or watching television, over longer-term health benefits. This concept is called present bias, where people place more value on immediate rewards than future ones. In all these scenarios, behavioural economics seeks to understand why individuals make irrational decisions and how they can be nudged toward making better ones.
FAQs about Behavioural Economics
What is Behavioural Economics?
Behavioural Economics is a field of economics that studies how psychological, cognitive, and emotional factors often cause individuals to make irrational financial decisions. It challenges the traditional economic theory which assumes that all economic decisions are made rationally.
Who are the pioneers in Behavioural Economics?
The most notable pioneers in Behavioural Economics are Daniel Kahneman and Amos Tversky. Their work on cognitive biases and decision making earned Kahneman the 2002 Nobel Memorial Prize in Economic Sciences.
What is the relevance of Behavioural Economics in today’s financial world?
Behavioural Economics is increasingly relevant today as it helps to understand consumer behaviour, make economic forecasts, and design economic and social policies. It’s valuable to companies in marketing strategies and product design, and to individuals in understanding their own decision-making processes.
How does Behavioural Economics differ from traditional economics?
Traditional economics assumes that people are rational and make decisions to maximize their utility. Behavioural Economics, on the other hand, considers the fact that human beings have limitations and biases that prevent them from making entirely rational decisions.
What are some practical applications of Behavioural Economics?
Behavioural Economics has practical applications in various fields such as finance, marketing, policy making, organizational behaviour, and even health care. It can help shape strategies related to savings and retirement planning, investment decisions, product pricing, and much more.
Related Entrepreneurship Terms
- Prospect Theory
- Cognitive Bias
- Heuristics
- Market Anomalies
- Loss Aversion
Sources for More Information
- BehaviouralEconomics.com: A website dedicated completely to Behavioural Economics and its related research and findings.
- Investopedia: A comprehensive financial website with a wide range of topics including Behavioural Economics.
- National Bureau of Economic Research: The website offers research papers and articles in various economic fields including Behavioural Economics.
- The Balance: A personal finance website with a behavioral economics section that can provide users with real-world applications of the subject.
