Written by Jennie Wang
In the last decade, there has been an increase in the number of behavioral economics books published, such as Freakonomics by Stephen Dubner and Steven Levitt, Thinking Fast and Slow by Daniel Kahneman, and Predictably Irrational by Dan Ariely. What has led to the creation and dissemination of behavioral economics and how has this new but popular concept shaped and influenced society?
In the 1970s, an economist named Gary Becker first used the phrase behavioral economics to describe rational choice theory—the idea that people always respond rationally and maximize self-benefits—and explain how people make decisions and respond to market forces (“An Introduction to Behavioral Economics,” 2020). Over time, other scholars began to delve deeper into the field. Considered the “Father of Behavioral Economics,” Richard Thaler challenged the belief that people are rational human beings with stable preferences who always maximize profits and minimize losses. He revealed that there are “anomalies” in human behavior that cannot be described through standard economic theory and that people are influenced by their environment, past experiences, and emotional and mental states (Gino, 2017).
After these discoveries, the idea of behavioral economics began to spread and increase in popularity. Because this field focuses on utilizing psychological insights to determine human behavior, economists have been studying how to not only understand but also manipulate and influence behavior through those psychological concepts, as opposed to policy and marketing changes. By using these psychological nudges, both government agencies and private markets can lower their costs and still achieve the expected economic results. For example, a common concept in behavioral economics is loss aversion, the idea that losses are more painful and impactful than gains. This partly explains why a seller will often demand a higher price for a good than a buyer is willing to pay for it. Taking this concept into consideration, advertisers often convince consumers to purchase their product by framing it in terms of a loss, stating that consumers will be worse off if they do not buy the product (Gal, 2018). A study completed in 2018 showed that households who were offered this “nudge” increased their electricity consumption by 2% more than households not exposed to the nudge of loss aversion (Abrahamse & Shwom, 2018).
After realizing that behavioral economics has become popular due to its ability to assist economists, researchers, and advertisers in understanding and influencing consumer behavior, it is necessary to look at how and to what extent the rise of behavioral economics has impacted society.
First, behavioral economics has assisted marketers. Through this field, marketers are able to understand consumer behavior and create products that fit consumers’ needs at their desired prices while also maintaining stability in the company’s sales. For example, traditional economics states that the cost of a good is proportional to the amount of money spent. However, behavioral economics argues that the relationship between cost and money spent is not directly linear, as there are many factors that ultimately affect the cost. Marketers have used this idea to develop the technique of payment delays. Because money is not as costly in the future in behavioral economics, people are more willing to spend money when the payment is at a later time, increasing the likelihood of them purchasing the product and increasing sales of the company. Another example is irrational value assessment, which states that humans believe cheaper goods are inferior and expensive goods and superior. Marketers take advantage of that idea as well and increase their prices, knowing that the higher cost could bring a higher simulated value to the goods and attract more buyers (“The importance of behavioral economics for marketers,” 2020). These concepts and many more taught within the field of behavioral economics assist marketers in creating more valuable goods and selling them in more efficient manners.
Behavioral economics also assists consumers by bringing to light their inner biases and decision-making processes. It allows people to be more aware of the limitations, motivations, and causes for their actions. For example, behavioral economics introduces the idea of short-term preferences, specifically projection biases. Projection biases prevent a person from making the optimal choice, instead reflecting what the person is feeling currently at the moment. If a buyer is hungry while he is shopping, he focuses on that hunger in the moment and buys more snacks and desserts than he would have normally purchased. By being aware of projection biases, consumers can make smart decisions in any context, from grocery shopping to social interactions. Another example is the tendency for people to overweight small probabilities, meaning they are so worried about the probability of a small incident from occurring that they are willing to pay 100% premium for insurance. This contradicts the expected utility concept taught in standard economics classes, which assumes consumers are rational and purchase the amount of insurance that is actuarially fair and fits the true probability of a bad event occurring. Being aware of this issue could encourage consumers to decrease the unnecessarily high premiums they pay for insurance (Mohsenin, 2017).
Behavioral economics has grown from the simple idea of understanding consumers’ responses towards markets to the complex and valuable study of consumer behavior and the irrationalities and complexities that are involved within it. By utilizing behavioral economics, both organizations and consumers benefit, whether that occurs through companies creating products and corresponding prices more tailored to the consumer or through consumers understanding their own thought processes and making wise choices in life.
References
Abrahamse W, Shwom R. Domestic energy consumption and climate change mitigation. WIREs Clim Change. 2018;9:e525. https://doi.org/10.1002/wcc.525
Gal, D. (2018, October 06). Why Is Behavioral Economics So Popular? Retrieved October 23, 2020, from https://www.nytimes.com/2018/10/06/opinion/sunday/behavioral-economics.html
Gino, F. (2017, October 11). The Rise of Behavioral Economics and Its Influence on Organizations. Retrieved October 23, 2020, from https://hbr.org/2017/10/the-rise-of-behavioral-economics-and-its-influence-on-organizations
The importance of behavioral economics for marketers. (2020, September 16). Retrieved October 23, 2020, from https://drivinginnovation.ie.edu/the-importance-of-behavioral-economics-for-marketers/
An Introduction to Behavioral Economics. (2020, October 14). Retrieved October 23, 2020, from https://www.behavioraleconomics.com/resources/introduction-behavioral-economics/
Mohsenin, A. (2017, January 12). How We Can Use Behavioral Economics to Improve Everyday Life. Retrieved October 23, 2020, from https://observer.com/2017/01/how-we-can-use-behavioral-economics-to-improve-everyday-life/