Introduction to Behavioral Economics

Economics is a branch of knowledge that is primarily concerned with the production, consumption, and transfer of wealth. To put it simply, it is the basis of all societal structure. In theory, economics makes it easy to predict human behaviour, as it is based on the assumption that we always make decisions that have optimal benefits. However, in practice it is not possible to understand human motive using this assumption, as we are not rational consumers, and make decisions based on arbitrary grounds like impulse and emotion.

The concept of traditional economics was developed against the backdrop of the idea that a consumer is a rational person, and is always able to weigh their costs and benefits to choose a product with maximum utility. It is assumed that the rational person always knows their preferences (both for the present and the future) and never pursues a harmful desire. Further, it is based in a perfect market scenario, where the consumers have complete knowledge of all products and can take rational decisions. This traditional economic approach is also known as the rational choice model. In reality, neither a rational consumer, nor a perfect market exist.

Therefore, in 2002, psychologist and economist Daniel Kahneman integrated perceptions from psychology and economic science concerning human decision-making, to create a more accurate economic model of human behaviour.  Kahneman’s insights were the introduction to the concept now commonly known as Behavioural Economics, which can be understood as a study of  ‘ the effects of psychological, cognitive, emotional, cultural and social factors on the economic decisions of individuals and institutions, and how these decisions vary from those implied by classical theory.’

It acknowledges that humans are emotional, unpredictable and usually make decisions based on whims and fancies that are not in their self-interest. For instance, when given a variety of options, consumers usually pick the default option, or one that is the most highly recommended. They are also likely to pick a popular brand, or something they have already owned in the past over a product with the maximum utility. All these are decisions influenced by the market demand, pop culture and the economic conditions prevailing in the region. This simply means that humans often do not act keeping in mind their best interests, despite having the option to do so. Since artificial distinctions like packaging and placing can influence sales, corporations often employ behavioral economics  to better influence their target demographic. In a supermarket for example, the most strategically placed product sells the most, while the others are shelved.

Richard Thaler, who recently won the Nobel Prize in Economics wanted to prove that all irrational human behaviour is an anomaly, and inspired the concept of ‘nudge units’. The Nudge Concept is considered to be one of the basic solutions to various government and business problems. It means that suggestions in the form of policies can affect all the choices we make. For instance, a survey found that when attendants ask customers if they want to size up their orders, most of them do, and similarly, 14 to 33% of customers also consume lesser calories if they are offered to downsize their order instead. This can be used to encourage positive change in the public, and propagate healthier lifestyles. For example, The Department of Health worked with the Behavioural Insights Team to help smokers quit smoking: e-cigarettes were introduced as a method to encourage quitters, as it was found that it is far easier to substitute an unhealthy choice with a similar behaviour, than to eliminate it entirely. The substitution method also proved to have long term benefits. This shows that humans are inconsistent, and fail to implement their goals without an external stimulus. Lessons from behavioural economics therefore, are not only beneficial to economists and marketing experts, but can also enlighten consumers and act as an external stimulus to nudge them in the direction of the right product.

We see that behavioural economics is a vast subject that can explain many human patterns. But it is also a way for avaricious corporations to sell their products. Therefore, consumers should try to completely understand the market, so they are able to choose products based on utility, rather than the way they are marketed.

Picture Courtesy- Indian National Interest

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