behavioral economics experts

behavioral economics experts

Exploring the Applications and Insights of Behavioral Economics

1. Introduction to Behavioral Economics

Behavioral economics draws on psychology and economics to explore biases embedded in people’s decision-making processes. While traditional economics plan decisions should be motivated by considerations of utility and self-interest, and do so in an optimal manner, behavioral economics makes no such presumptions about the utilization of utility, about individuals (people are not perfect agents), and about their interests (people care about a lot of other things beside their own material well-being).

Notably, behavioral economics implies two broad sets of predictions about choice behavior: some simply predict systematic biases or errors. These are the “weak” predictions. These errors appear to be present for everyone and everywhere. Others predict the opposite, i.e., a decision-maker acts in the opposite way, though at different points. For example, I assume that I will stop exercising (financial planning, saving, attending a performance) too soon, while you think you will continue to “burn money” forever. These are “strong” theoretical predictions.

Although the predictions of behavioral economic theory are wide-ranging and diverse, the rationale that constitutes its message is straightforward. People are not rational, not all individuals are irrational, not all decisions are poor, and these anomalies are predictable. The rationality limitations that this argument presents have significant and direct implications for the practice and development of government policy.

Indeed, since behavioral economics extends our understanding of human behavior in ways that are not expected by traditional economics, behavioral economic research offers vital insight for policymakers seeking to develop public policy interventions. The argument behind this assertion is also straightforward. Individuals do not only pursue stable but context-free goals but are willing to forgo their own benefits without appropriate nudges. These individuals – and certainly policymakers – will be pleased to know that there are many tools available to nudge people towards making decisions that are better than the old ones.

2. Key Concepts and Theories in Behavioral Economics

Behavioral economics is a relatively new field of economics that has developed rapidly over the past few decades. It is primarily concerned with the empirical assessment of choices made by actual agents contained within realistic and sometimes not fully competitive environments. As such, it poses a large challenge to the competing model of rational man operating in a fully competitive environment. Several refinements have been incorporated within the general framework during the period of development. This chapter covers the key concepts and theories in behavioral economics such as fundamental theories of behavioral economics, fairness concerns, altruism, and warm-glow giving, endowment effects and the status quo bias, heuristics, and choice set effects.

Fundamental theories of behavioral economics are models that account for self-imposed decision-making restraints without invoking some form of external enforcement. Only behavior that appears to be based on non-economic factors will be classified as evidence of non-economic decision-making rules. However, our understanding of the empirical and experiential state of human decision-making is still rudimentary. There are three fundamental techniques to empirically assess the decision-making process. First, experimental economics uses laboratory techniques to directly observe variations in the relevant decision-making incentives. Second, the revealed preference approach allows for a thorough investigation into the reasons for any departures from the original model of economic behavior. Third, structural estimation techniques are employed to recover underlying non-economic objectives from the observed behavior of individuals.

3. Practical Applications of Behavioral Economics in Policy Making

The insights of behavioral economics may also find application in the area of consumer protection policy where, again, the standard response is regulation and, in many developing countries, a growing interest in consumer protection. We argue that when regulation is called for, behavioral insights can provide a more nuanced understanding of the type of regulation required. There can also be welfare-enhancing benefits from market “dysfunction” where, in most instances, constraints on the use of such contributions can be relaxed in well-specified ways. These insights also provide implications for the importance of prudential supervision in markets for consumers’ financial security.

Finally, in seeking to reduce poverty, transferring wealth to the poor is clearly required. Much overseas development assistance is allocated to addressing these poverty concerns in the form of preference-revealing cash transfers. We argue that the alternative of treating cash as a Parent’s Allowance and building, through development assistance, infrastructure that simultaneously increases the opportunities available to non-donor parties and provides parents with an income in exchange for ensuring their children participate in the new opportunities can provide a more appropriate and ultimately more successful path to development.

4. Behavioral Economics in Marketing and Consumer Behavior

Behavioral economists have been increasingly interested in applying their behavioral knowledge to the consumer and how individuals make decisions as customers. It is not surprising that many of these applications begin with shopping and marketing. Behavioral economics can provide a tool to help marketers make decisions about product positioning and pricing. There is naturally a reciprocal flow of information, where lessons from real-world marketing help us design and develop more powerful theoretical models. Our main goal, however, is to offer a broader perspective.

We look at consumer behavior from several starting points. One theme is to take, at least at times, the view of the firm. Sellers are also buyers and, over time, buyers become sellers. We attempt to understand the results of individual and group sellers’ decisions relating to both private and professional purchases. In some cases, we find that it is possible to understand the patterns that emerge from these decisions only if we abandon the traditional (neoclassical) focus on the revealed preferences of the agents in one of these roles. While this approach might appear peculiar initially, those who deal frequently with marketing and company-organization issues seem to appreciate that it is rooted in an important and prevalent aspect of the business world.

5. Future Directions and Emerging Trends in Behavioral Economics

An increasing number of fields have found reason to apply insights from behavioral economics, creating a natural incentive for government to think about how those insights might improve the effectiveness of public policy interventions. Although critics of behavioral economics insights argue that the benefits of choice architecture will be evident only in the laboratory setting, policymakers in charge of decisions affecting the thousands of citizens in the field of public policy do not have the same set of incentives as private firms and do not operate in the same profit-maximizing way.

We have only started to uncover lessons that could be applied to specific policy-making questions, and there are many other questions that have not yet been explored. Yet, while understanding the weaknesses and limitations of behavioral economics is important in calibrating the way it can benefit public policy decisions, it still represents an important evolution in understanding human – more precisely, individual – decision making.