Behavioural Economics

The study of how the subconscious influences decision making and judgements

Background

Behavioural economics is the study of how the subconscious can bias decision-making and judgements under certain conditions. The subject seemingly invalidates the assumption of rationality underpinning classical economics and has gained significant attention in recent years given its implications within a wide range of applications, from investing to health care.

The subject was pioneered by Daniel Kahneman, who was awarded the Nobel Prize for Economics in 2002. Kahneman posits that decision making is influenced by automatic, intuitive ‘System 1’ processes that employ a range of simplifying heuristics. While these are monitored to an extent by more rational but slower ‘System 2’ processes, they are not always overruled, resulting in predictable biases. A wide range of factors have been shown to influence System 1 processes, including:

Social Proof

The extent to which other people are perceived to embrace something influences a decision maker’s perception of it. This effect is stronger where those observed are deemed to be similar in some way to the decision maker. This explains why salespeople will often attempt to establish common ground with prospective customers, while hotels are more effective in encouraging towel reuse by conveying that most guests do so rather than emphasising the resultant environmental benefits.

Confirmation Bias

People tend to look for/favour evidence that confirms existing beliefs while discounting information that runs counter to these. This tendency results form an inherent aversion to incongruence between beliefs and actions (‘cognitive dissonance’), which has been shown to result in people believing what they say, even when they are paid to say it. Related to this is the Halo effect, where a positive / negative initial impression influences interpretation of subsequent ambiguous events.

Local Environment (Priming Effects)

Numerous factors within the immediate environment of somebody can bias thinking and decision making in predictable way. For instance, sitting on a wobbly chair has been shown to increase the desire for stability, while exposure to images of money has been shown to make people more selfish.

Loss Aversion & the Ikea Effect

People dislike losing something more than they like gaining something of an equivalent value. This biases the status quo through emphasising the disadvantages of a change over the advantages and explains why the price at which we would sell something is generally higher than we would be willing to pay for it. Similarly, expending effort on a task causes people to place an irrationally high value on the result (the IKEA effect).

Temporal Factors

People tend to undervalue the future, making them more likely to engage in something with an immediate payoff but future cost (e.g. smoking). In addition, actions are impacted by recent events (availability bias). For instance, drivers will tend to be more cautious in the immediate aftermath of observing an accident. Furthermore, people have a general inclination to overestimate the likelihood of positive events in the future (the Optimism Bias).

Information Presentation

The way that logically equivalent choices are presented, for instance in description (e.g. saving lives instead of preventing deaths), relative positioning (e.g. offering clearly inferior options may increase sales of the slightly better options) or use of statistics versus relative frequency will alter perceptions of these options for a decision maker. For instance, presenting an option as a default increases the chances of it being adopted.

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