Behavioral Economics Definition Examples Applications

Behavioral Economics Definition

Behavioral Economics aims to understand economic decisions made by humans by combining elements of psychology with classic economics. This branch of economics looks into how and why people arrive at their economic choices, how they differ from rational choices, and find the implications they have on various aspects of life.

It bridges the gap between neo-economics and reality. Behavioral economics assumes that humans are rational and study why they make deviated choices from logical decisions. The goal is to understand how different types of information influence individuals’ decision-making skills and how their cognitive limits and psychological biases affect socio-economic and political outcomes.

Key Takeaways

Behavioral economics differs from traditional economic theory. It helps understand why people make their choices, deviating from rational decisions. This concept studies the factors influencing them and makes small changes to persuade people to make conscious choices.Human decisions are influenced by factors such as Bounded rationality, choice architecture, cognitive bias, discrimination, and herd mentality.The objective is to study how different types of information influence people’s decision-making and how people’s cognitive limitations and psychological biases influence socio-economic and political outcomes.Governments, organizations, and businesses use behavioral economic studies to motivate people to make certain kinds of decisions.

Behavioral Economics Explained

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Behavioral economics theory attempts to look beyond the traditional economic theory, which is based on “rational choice.” This concept presents humans as logical beings. When presented with multiple alternatives, they assess the pros and cons of each option and choose one that serves them best. However, in reality, buying trends of consumers suggest otherwise. They do not always choose the obvious logical option, and hence behavioral economic studies yearn to understand why people act, defying rational choices.

It was Richard thaler, a Chicago scholar, who first examined the idea of the emotional side of human beings and its effect on decision-making rather than people following optimal routes, which looks like an obvious action. But the original attempts at understanding these ideas go back to studies of 18th-century economists like Adam Smith.

The behavioral models have helped governments and businesses alike create policies and game plans that can influence people’s financial behavior.

One can condense behavioral economics principles into the following points:

People try to choose the best option available, but they don’t always succeed.They are concerned about how their situations compare to benchmarks (such as money).People have issues with self-control.In markets, too, psychological variables play a role. People can be partially protected from behavioral biases by restricting their options. (However, in reality, it is not found to be true in most cases.)

Factors Influencing Human Decisions

According to behavioral economics theory, human decisions are influenced by various factors such as:

#1 – Bounded Rationality

Individuals tend to make informed decisions based on their limited knowledge. They conclude that having the required amount of information is sufficient and create a “good enough” decision rather than the best possible one.

#2 – Choice Architecture

Presentation of goods has an impact on people’s decisions. Pens, and ink, for example, are complementary commodities, and presenting them together can help enhance ink sales more effectively than if sold separately.

#3 – Cognitive Bias

Individuals make choices based on their beliefs and values and how they interpret the world. For example, suppose a person likes a particular color. Then, they are likely to buy products that are particularly not useful because it is their favorite color and pleases their eyes.

#4 – Discrimination

Here, individuals tend to reject choices based on their dislike. Preconceived biases unrelated to the actual situation can play a huge role in discriminating against an idea. They can favor other decisions because of their aversion to the alternatives.

#5 – Herd Mentality

People like a sense of belonging, whether to faith, a country, a language, or even their favorite sports team! So people spend money they would not otherwise spend to fit in and be recognized as a group member.

The subject attempts to study these factors and behavioral economics principles mentioned above that influence an individual’s decision-making ability and prompt them to make better decisions.

Examples of Behavioral Economics

The following behavioral economics examples are provided to give readers a basic understanding of the concept:

Example #1

As a customer in a mall, Sam came across signs for a product that said $999 instead of $1000, and she chose to purchase it because the price was below $1000. There is no big difference in value between $999 and $1000. There was not much gain saving that $1, but what made her choose to buy that product was the satisfaction of purchasing a product under $1000. It was rather an emotional decision rather than a rational one.

There are countless behavioral economics examples, such as these, that we come across in our daily lives where industries take advantage of human behavior.

Example #2

Google promoted the consumption of widely disliked vegetables (beets, Brussels sprouts, cauliflower, etc.) through an experiment.

Instead of mailing the employees the benefits of Brussels sprouts, they advertised it as “vegetable of the day” and displayed colorful pictures and intriguing facts. Placing them right next to the dish made people choose it. As a result, the number of employees who tried the highlighted dish jumped by 74%, and the average amount each individual served themselves increased by 64%.

Experiments such as these are part of behavioral economics research. They demonstrate how little nudges can influence people’s behaviors. Positive changes such as these reduce consumption of junk food and keep them healthy. It decreases their chances of health issues and increases productivity. Many companies can also benefit economically from such changes.

Application of Behavioral Economics

There are various uses of behavioral economics across industries, for example:

#1 – In a market

Companies make use of the predictable behavioral tendencies of people. For example, if there is a product sold for $10, the chances of it gaining more sales are increased when it is advertised along with another product for a small increase in price. Two products for $12 will be a great deal in the customers’ minds.

#2 – Policy implications

Let’s say it is election time, and every vote counts. So the government can send a small text reminder to the people’s phones to come to do their duty as the country’s citizens. This will urge people to come forward to vote who otherwise would have ignored the opportunity. This little push can decide the fate of a country for a few good years and the economic policies to be framed in that period.

Studying people’s reasoning behind their decisions can reveal what they intend to achieve through that decision. It may be psychological satisfaction, economic relief, or other reasons. This knowledge helps various stakeholdersStakeholdersA stakeholder in business refers to anyone, including a person, group, organization, government, or any other entity with a direct or indirect interest in its operations, actions, and outcomes.read more guide the masses into choosing what they desire through encouragement such as free products and reminders, as mentioned above.