behavioural economics

• Traditional economic theory


  Creating a theory and using it to explain actual behaviour
• Behavioural economics


  Observing actual behaviour and then coming up with the theory
• Assumptions of traditional economic theory

  • Homo economicus or 'economic man' is self-interested and only care about himself
  • People know the consequences of everything they do
  • People are rational
  • People know what they want and always act on these preferences
• Assumptions of behavioural economics

  • People are altruistic (they have some concerns for the wellbeing of others)
  • People are generally impatient and lack self-control
  • People dislike change 'status quo bias' unless the incentive to change is compelling
  • People make decisions using rule of thumb called heuristics
  • The role of emotions in decision making
  • Limitations to compute and reason
• Bounded rationality


  Imperfect information on possible alternatives and their consequences, limited mental processing ability, and a time constraint
• Bounded self-control


  People have limited self-control e.g., consolidating learning, reading more over summer
• Thinking fast and thinking slow

  • Thinking fast - intuitive and instinctive (decisions are made quickly and little effort required)
  • Thinking slow - reflective thinking (requires mental effort and concentration)
• Availability bias


  Making decisions based mainly on probability-recalling similar experiences, events
• Anchoring bias


  Predictable bias involved in making decisions based on a limited set of items 'anchoring effect'
• Altruism


  Having concerns for the welfare of others
• Fairness


  The quality of being impartial, just, or free of favouritism
• When making day-to-day decisions, consumers rarely behave in a well-informed and rational way
• Behavioural economics


  Mixes insights from Psychology with Economics and looks at problems through the eye of a "Human", rather than an "Economic Man"
• Economic Man


  Infinitely rational and immensely intelligent, an emotionless being who can do cost-benefit analyses at will and is never (ever) wrong
• Bounded rationality


  Most consumers do not have sufficient information to make fully informed judgements when making their decisions
• Satisficing


  Consumers opt to satisfice rather than maximise
• Heuristics


  Mental shortcuts or rules of thumb for decision-making to help people make a quick, satisfactory, but perhaps not perfect, answer to a complex question
• Heuristics can lead to systematic deviations from logic, probability, or rational choice theory, resulting in cognitive biases
• Default bias


  People prefer to carry on behaving as they have always done
• Choice architecture


  How the decisions we make are affected by the layout/sequencing/range of choices that are available
• Social norms


  Our day-to-day behaviour is influenced strongly by what we understand to be the prevailing social norms or social customs
• Herd behaviour


  We are herd animals, and we often make decisions based in part on who is around us and the choices they make
• Anchoring


  Value is often set by anchors or imprints in our minds which we use as mental reference points
• Priming


  Our behaviour by cues that work subconsciously and prime us to behave/ choose in certain ways
• Framing


  Framing a question or offering in a different way often generates a new response by changing the comparison set it is viewed in
• Availability bias


  The availability bias happens we people often judge the likelihood of an event or frequency of its occurrence by the ease with which examples and instances come to mind
• Commitment


  The more public our position, the less willing we are to change it
• Examples of behavioural economics

  • Organ donation and importance of form design
  • Cash incentives to stop smoking
  • "chunking" to increase drug treatment completion
  • Lotteries to encourage weight loss or cut speeding on roads
  • Using simple checklists in hospitals to reduce number of x-rays
  • Choice architecture to encourage healthy eating
• Behavioural nudges


  • Elimination or restricting choices
  • Financial disincentives to take a particular course of action
  • Influencing choice
• Behavioural economics may encourage governments to become too paternalistic in their policies attempting to nudge behaviour
• Behavioural economics focuses too heavily on people's vulnerability to fall for fallacies and their psychological biases- it can give the impressions than consumers are dumb
• Consumers using well-practiced rules of thumb might be operating in a rational way
• There are limits to nudge theory- it may be useful in changing minor behaviours but not in deep rooted psychological problems such as alcoholism and street violence
• Minsky's 'financial instability hypothesis'


  Three distinct stages
• Hedge


  After crisis- banks are cautious and offer modest borrowing (being able to pay loan and interest)
• Speculative


  Confidence grows and borrowers only pay interest and loan against an asset. Stage one a distant memory
• Ponzi finance


  Loan to firms/household- cannot pay loan or interest in the belief that the asset prices will rise. At this point stage two is a distant memory
• Rising asset prices


  When they eventually fall then borrowers/banks realise there is debt in the system that can never be paid off. People risk paying for assets causing an even larger fall in prices
• Behavioural economics


  Riskier, there are irrational behaviour
• Neoclassical economics


  All behaviour is assumed to be rational