Behavioural Economics is a subfield of Economics that focusses on the conduct of individuals in economic affairs and systematically tracks how it deviates from rational expectations. While the homo oeconomicus model of classical economics assumes that our actions are predominantly predicated on careful cost-benefit analyses, they are in fact shaped by a range of social, psychological and cognitive factors. Our experimental research elucidates how decision-making processes actually transpire, allowing us to develop effective means of influencing them and predicting outcomes more reliably.
What is Behavioural Economics?
The Uses of Behavioural Economics
Although cash is essentially interchangeable, many of us tend to run a system of mental accounts to prioritize transactions by origin or use. The resulting restraint is sometimes beneficial in that it helps us avoid unduly impulsive transactions, but it can also lead to costly financial errors.
Our decisions are shaped substantially by the environment in which we take them. Evolutionary biology dictates that all our judgments are rooted in environmental stimuli. This brings with it the risk that we treat irrelevant information as though it were relevant. To give an example, research has shown that entirely unrelated numbers (the last three digits of our phone number) can influence fundamental economic judgments (the value of our own house).
When it comes to our own lives, we tend to be remarkably optimistic. Most of us assume that others are much more likely to be struck by misfortune than we are. The average smoker is a case in point. Many smokers will acknowledge the risks associated with smoking in general and yet assume that they themselves are less likely to suffer its detrimental effects than others.
The more readily we are able to recall information about a possible event, the more likely we are to assume that it will occur. This mechanism, which can make us systematically misjudge risks, weighs particularly heavily when access to information is limited. Shark attacks are a case in point: because they feature so prominently in the press and public imagination, many of us overestimate the risk of encountering a shark attack ourselves.
We tend to prioritize instant or short-term benefits disproportionately over long-term benefits. Discounting does not occur exponentially. We tend to discount imminent transactions more than those in the distant future. Presented with the choice of receiving €100 or €110 in a year’s time, most people will opt for the €110. Yet presented with the choice of receiving €100 now or €110 in a week’s time, most people will take the €100 now.
We tend to underestimate the impact our emotional and physical disposition has on our decision making. Consequently, many of us have difficulties predicting our future conduct accurately. We may, for example, swear off sweets when we have just had a meal and yet automatically reach for a bar of chocolate when we next feel peckish. Very few people who have just had a meal are able to predict with any accuracy how they would act when they are hungry.