Behavioral economics combines elements of both economics and psychology in order to understand why people behave in certain ways in the real world. It differs from neoclassical economics which assumes that most people have well-defined preferences that lead to self-serving decisions based on these preferences.
Researchers in this field have explored heuristics and biases that cause people to make irrational choices, including Amos Tversky, Daniel Kahneman, Dan Ariely, and Richard Thaler.
Thaler first recognized behavioral economics when his observations showed that humans’ intertemporal choices varied significantly from traditional economic models in predictable ways. Through their studies and those of Tversky and Kahneman, behavioral economics has evolved as an academic discipline examining specific psychological variables which influence decision-making processes.
These include our tendency to seek pleasure from things easily available, repeated or vivid; the sunk cost fallacy and present bias; as well as people’s preference for fairness over inequality. Furthermore, people have difficulty maintaining self-control; they impose short-term restrictions but struggle to adhere to them.
Applied correctly, behavioral economics can assist individuals in overcoming financial obstacles and making smarter financial decisions. Unfortunately, behavioral economics often involves using nudges without full awareness or consent, leading to ethical concerns and infringing upon personal autonomy. Furthermore, most behavioral economics experiments take place within Western educated, industrialized, rich and democratic societies (WEIRD), potentially limiting generalizability to other populations or contexts; nonetheless, its insights have profound consequences in our everyday lives.
Anchoring refers to a cognitive bias where the first piece of information received can have an influence over your perceptions of subsequent information in a situation.
Example: If you’re shopping for a new car and the initial price presented to you is $30,000, that can skew how you perceive its true worth; in turn causing you to adjust its final cost in ways which may not be fair to both parties involved.
Psychologists and economists like Daniel Kahneman and Amos Tversky conducted experiments utilizing the anchoring effect to demonstrate how people tend to make judgments based on initial information given, causing bias that may influence your shopping experiences, pricing decisions or negotiations with others.
Critics of behavioral economics contend it overemphasizes human irrationality; however, researchers such as Thaler at the University of Chicago continue to conduct field experiments to explore how various factors impact decision-making processes and use principles from behavioral economics to design programs – for instance placing healthy food closer to eye level in cafeterias to encourage students to make healthier choices.
Behavioral economics focuses on emotions and the effect they have on decisions. It does not assume people are incapable of making rational choices; rather, it recognizes our emotional side can sometimes interfere with this process.
Behavioral economics suggests that changing how you view money may help if you grew up witnessing your parents overspending. Setting clear financial goals and employing technology-enhanced savings tools are also ways to overcome present bias and establish sustainable habits.
However, many of the strategies behavioral economists employ to nudge people toward better behaviors can raise ethical concerns. For instance, they could be used to manipulate individuals without their knowledge or consent and many behavioral economics experiments are conducted in Western, educated, industrialized, rich and democratic (WEIRD) societies which may not represent global populations fully; making it harder to ascertain if and where these insights might apply broadly; nonetheless researchers like Richard Thaler are making strides forward in pushing this field forward.
Behavioral economics challenges the traditional assumption that people make choices as rational, self-serving individuals with stable preferences. Instead, it examines why decisions deviate from optimal decisions and what can be done to influence those choices for consumers, businesses, managers or governments.
Thaler and other behavioral economists assert that human decisions can often be affected by factors like their environment or how information is presented; as a result, their decision-making processes might differ between people from similar backgrounds and circumstances.
Luis Garcia, a mutual fund manager with MAPFRE AM, states that it can be easy to misinterpret the behavior of one individual as representative of all. Whether or not BE principles apply to you depends on your personal history, thought process and level of rationality.
Behavioral economics doesn’t imply that you are irrational, or even flawed; rather, it indicates how we are easily distracted by modern life and vulnerable to external influences; particularly in financial contexts where these biases can have significant ramifications.