What is behavioural economics? To explain observed behavioursand market outcomes Behavioural economics applies psychological principles. Itis possibly more precisely referred to as psychology and economics’. In itself, the concept ofbehavioural economics is not especially new, it established in 1970s/early1980s with the work of psychologists Daniel Kahneman and Amos Tversky (1979),and the economist Richard Thaler (1980).
But it got the attention from thepublic because popular books on economics and psychology such as Nudgeand Predictably Irrational,17and by Daniel Kahneman published and winned the Nobel Prize for Economics in2002. In recent years the theoretical, empirical and experimental literature onbehavioural economics and consumer biases has also moved on meaningfully.Atits core, behavioural economics provides insights into individuals’behaviour. Traditionaleconomic models make a variation of implicit or explicit assumptions aboutpeople’s preferences, cognitive ability and rationality.
These provide thebasis for a useful, tractable framework for explaining market outcomes.In specific, traditional modelsassume that people’s preferences are reasonably free from external influence. Fromown experience People regularly update their own information , moreover theylearn from their past experiences. With the final aim of maximising theirutility they also use all accessible information to make fully rationaljudgements. By these assumptions, it is probable to make properly direct forecastsabout how consumers will behave based on their preferences, their budget andthe prevailing prices of different goods in the marketplace. It is notconsidered necessary to explore in any detail why they make thesedecisions.
Buton the other hand, behavioural economics try to assimilate theory and practicefrom the psychology literature into economics. The approach has been toidentify assumptions in traditional economics that may not be realistic; todemonstrate anomalies; and, where possible, to propose alternatives. Why peoplemay face a variety of problems in processing information and making decisions,mainly the behavioural economics discuss about this.Behaviouraleconomics can help to explain why search and switching costs might arise,furthermore how consumers actually make decisions. From a regulatoryperspective, however, understanding such processes is important only as a meansto an end.
Comparingtraditional and behavioural economicsStylised representationof cognitive and behavioural processes involved in making choices Working from left to right, basictraditional economic models make a number of implicit or explicit assumptionsthat underpin the outcomes of these models. – Preferences donot depend on context. Traditional models assume that, preferences are notaffected by the way in which information is presented or framed’. If the materialof the information is the same, the same decisions will be made. In short,preferences are not reference-dependent. – Decision-makinginvolves fully rational deliberation.
Traditional economics assumes that, whenmaking decisions people use all available information and that they are able to remember their pastexperiences. It is also assumed that consumers engage in rational, consciousreasoning to weigh up the best course of action. – Choices over time aretime-consistent. Traditional models assume that, consumers behave in atime-consistent way. Behaviouraleconomics assumptions:– Preferences depend oncontext. Preferences are reference-dependent. For example, The prospect ofa reward of €400 may be needed in order to outweigh the prospect of a penaltyof €350.22 This is called loss aversion’, or the endowment effect’.
– Decision-making involvestaking shortcuts. Making decision would be tiring to apply to allday-to-day tasks. We make some decisions purely subconsciously andautomatically. In addition, between conscious andsubconscious decision-making lies a series of shortcuts known as heuristics’.
For example, individuals may make quick decisions based on a selection of theinformation provided in the marketplace, their memories of recent experiences,looking to what others are doing, or focusing on what they think are salientaspects of the information. Heuristics saves a lot of time and effort, inparticular when dealing with complex problems, but can be imperfect and open toexploitation by firms. – Choices over time can betime-inconsistent. Consumers can face a conflict between their short-termurges and what would be best for them in the long term. In economics language,their preferences can be present-biased’or time-inconsistent’relative to whattraditional economics would predictWhat is behavioural economics?To explain observed behavioursand market outcomes Behavioural economics applies psychological principles.
Itis possibly more precisely referred to as psychology and economics’. In itself, the concept ofbehavioural economics is not especially new, it established in 1970s/early1980s with the work of psychologists Daniel Kahneman and Amos Tversky (1979),and the economist Richard Thaler (1980). But it got the attention from thepublic because popular books on economics and psychology such as Nudgeand Predictably Irrational,17and by Daniel Kahneman published and winned the Nobel Prize for Economics in2002. In recent years the theoretical, empirical and experimental literature onbehavioural economics and consumer biases has also moved on meaningfully.Atits core, behavioural economics provides insights into individuals’behaviour. Traditionaleconomic models make a variation of implicit or explicit assumptions aboutpeople’s preferences, cognitive ability and rationality.
These provide thebasis for a useful, tractable framework for explaining market outcomes.In specific, traditional modelsassume that people’s preferences are reasonably free from external influence. Fromown experience People regularly update their own information , moreover theylearn from their past experiences. With the final aim of maximising theirutility they also use all accessible information to make fully rationaljudgements. By these assumptions, it is probable to make properly direct forecastsabout how consumers will behave based on their preferences, their budget andthe prevailing prices of different goods in the marketplace.
It is notconsidered necessary to explore in any detail why they make thesedecisions. Buton the other hand, behavioural economics try to assimilate theory and practicefrom the psychology literature into economics. The approach has been toidentify assumptions in traditional economics that may not be realistic; todemonstrate anomalies; and, where possible, to propose alternatives. Why peoplemay face a variety of problems in processing information and making decisions,mainly the behavioural economics discuss about this.
Behaviouraleconomics can help to explain why search and switching costs might arise,furthermore how consumers actually make decisions. From a regulatoryperspective, however, understanding such processes is important only as a meansto an end. Comparingtraditional and behavioural economicsStylised representationof cognitive and behavioural processes involved in making choices Working from left to right, basictraditional economic models make a number of implicit or explicit assumptionsthat underpin the outcomes of these models. – Preferences donot depend on context.
Traditional models assume that, preferences are notaffected by the way in which information is presented or framed’. If the materialof the information is the same, the same decisions will be made. In short,preferences are not reference-dependent. – Decision-makinginvolves fully rational deliberation. Traditional economics assumes that, whenmaking decisions people use all available information and that they are able to remember their pastexperiences. It is also assumed that consumers engage in rational, consciousreasoning to weigh up the best course of action. – Choices over time aretime-consistent. Traditional models assume that, consumers behave in atime-consistent way.
Behaviouraleconomics assumptions:– Preferences depend oncontext. Preferences are reference-dependent. For example, The prospect ofa reward of €400 may be needed in order to outweigh the prospect of a penaltyof €350.22 This is called loss aversion’, or the endowment effect’.
– Decision-making involvestaking shortcuts. Making decision would be tiring to apply to allday-to-day tasks. We make some decisions purely subconsciously andautomatically. In addition, between conscious andsubconscious decision-making lies a series of shortcuts known as heuristics’.For example, individuals may make quick decisions based on a selection of theinformation provided in the marketplace, their memories of recent experiences,looking to what others are doing, or focusing on what they think are salientaspects of the information.
Heuristics saves a lot of time and effort, inparticular when dealing with complex problems, but can be imperfect and open toexploitation by firms. – Choices over time can betime-inconsistent. Consumers can face a conflict between their short-termurges and what would be best for them in the long term.
In economics language,their preferences can be present-biased’or time-inconsistent’relative to whattraditional economics would predict
