Behavioural economics

 What is Behavioral Economics?

Behavioral Economics refers to the psychology study since it is associated with the decision-making process in terms of the economy of an individual or an institution. Behavioral economics asks two very crucial questions – first is whether the assumptions made by the economists on the maximization of profit as being the better estimates of the real behavior of people and second is whether the individual enhances the expected subjective efficacy. Behavioral economics is explained more clearly using the various theories of economics including the rational choice theory.

This theory asserts that humans always opt for the thing that enhances their personal satisfaction.  It also states that individuals, along with their restrictions and preferences are able to make practical decisions efficiently by measuring the benefits and expenditures of all the options that are are available to them. Amongst the many applications, one application of the subject is heuristics, a method for solving problems that utilize easy ways to yield credible solutions within a limited period. Behavioral economics takes help from both economics and psychology to understand the reason some people make irrational decisions sometimes and the way such decisions fail to follow the predictions made in the economic models. Decisions involving even the smallest things such as choosing a cup of coffee or joining a particular college or university are those types of decisions that the majority of individuals make in their lives. Behavioral economics looks to explain the reason for an individual to choose one option over the other.

What is something that behavioral economics explains clearly?

According to behavioral economists, the subject of behavioral economics explains loss aversion very succinctly. As behavioral economics explains, individuals make decisions that they believe yield maximum profit. Thus, this decision made by the individuals invariably leads to loss aversion. However, it is important to note that traditional behavioral economists consider 2 minus 1 as the same as 1, which is not true. While the value 1 could represent profit, 2 minus 1 represents a loss.  It is human psychology that people are more affected by loss than they are influenced by profit.  Daniel Kahneman and Amos Tversky are considered the founding fathers of behavioral economics who conducted researches to determine the heuristics and biases of the people while making decisions.

The researchers found that when human beings are confronted with complex decisions, they tend to look for shortcuts and concentrate on just one aspect. This tendency called the heuristics to save the day most of the time for humans but it also results in cognitive biases. An example of this is that the people mostly judge the probability of any event based on the ease with which humans could think of a good example. Kahneman and Tversky also talked about the prospect theory, which explains that humans are more concerned about the losses that might occur from a situation rather than the benefits. This leads to loss of aversion, which is the most clearly explained thing in behavioral economics.

 What are the biggest insights from behavioral economics?

Loss aversion, endowment effect, high stakes decision, sunk costs and irrational actions, and self-control are the biggest lessons to learn from behavioral economics.

Loss aversion – This explains that people tend to feel increased pain when they lose a penny rather than gaining the same amount. For instance, a person who has lost 100 dollars would feel heartbroken even if he has gained the same amount.

Endowment effect – The endowment effect is simply the satisfaction individuals have when they own an item. The individual feels satisfied thinking they she or he would be able to sell the item at a price higher than which would, she or he bought it.

High stakes decision – According to this component, individuals hardly make optimal decisions during situations that are designated as high stakes. However, high stake situations do not necessarily result in high-quality decisions. Examples of high stake decisions include marriages, buying, or selling mortgages. These decisions are made only once or twice in life and thus provide the least opportunity to learn or avoid mistakes.

Sunk costs and Irrational actions – This could be explained using the example of a person who pays say, 1000 dollars for a gym membership. However, after a few months, the person stops going to the gym owing to the hardships faced during exercise and then quits.

Self-control – This is opposed to references in a majority of the cases. The people often go for the things they prefer the most even if it is harmful to them. Self-control is a rarity because few people learn to do it.

 Why is behavioral economics important?

The importance of behavioral economics could be understood from the fact that it uses research, experiments, and observations to observe the behavior of human beings so to uncover the way they think. Behavioral economics is renowned for providing a scientific explanation for the decision-making process of humans. Behavioral economics helps businesses to look at the bigger picture by understanding the decision-making of the consumers. The subject helps the business in finding solutions to the questions relating to the consumer such as the rationality or emotion of the decisions, the quickness of the decision, the amount of information consumed by the consumer and the importance of the context in influencing the brand’s perceptions. Behavioral economics helps in answering these questions, which in turn, makes the business very effective.

The reason that behavioral economics utilizes psychology to analyze the behavior of human beings especially in terms of decision-making makes it an important subject. The subject has been able to incarcerate the popular imagination because of its emphasis on psychology to be combined with economics. Prior to behavioral economics and the experiment by Kahneman and Tversky, hardly any author had even thought about incorporating psychology into economics. The proponents of behavioral economics suggest that the subject has become popular because it has provided increased accuracy to economics with the incorporation of added pragmatic assumptions regarding the behavior patterns of human beings. Nonetheless, many behavioral economists have attempted to explain the how of human behavior deviation rather than why. Despite this fact, behavioral economics has been a revolution of sorts in the field of economics.

 Is behavioral economics coherent?

Behavioral economics is quite logical because it has been founded not on mere assumptions but on experiments and researches. Behavioral economics is being increasingly used in businesses to boost sales. Using the behavior economics, marketers of the iPhone in 2007 introduced the product at 600 dollars initially and then in no time, reduced the price to 400 dollars. In the view of behavioral economists, had the marketers introduced the phone at 400 dollars at the beginning itself, people would have found it very costly.

They introduced it a higher price and reduced it later to make the consumers believe that they have bought the phone at a very good price. This led to a massive surge in sales for the Apple Company in 2007.  However, it is crucial to understand that companies should not think their consumers are always irrational because then, it might not produce the desired results. This is one aspect of behavioral economics that critics point out as being flawed. Nevertheless, the subject has enabled companies and businesses to make their decision-making process an efficient one. Some also state that economics must not be only about graphs, numbers, and tables because of this only helps in examining and explaining the things that had happened in the past. These do not have the ability to predict what could happen in the future. to predict the decisions and behavior of the humans, it is important to incorporate into economics, the tool of psychology. Behavioral economics has been able to incorporate effectively, psychology into economics thus making it an effective and coherent subject.

 How lucrative is the field of behavioral economics?

Behavior economics has been a very recent phenomenon and people are still coming to terms with it. However, once individuals learn about the subject, they are able to access the complex concepts of economics and business to become successful. Behavioral economic acts like a hunter for the people who look for demand, especially those who do not have any big brand name or expertise in it.

For the suppliers though, several behavior economics concepts are easily accessible and this makes it easier for the suppliers to enter the field. However, it is essential to note that in order to become an expert in the field, one must have the research, education, familiarity, and experience because highly capable people are a rarity. This has led to behavioral economics is an option for large firms. The depth level has some variations but it is typically more elementary as opposed to the severity one sees in the academic field. To make it more complex, the greatest worthy applications present themselves in the midst of behavioral economics along with industry specificity, innovation and the amalgamation of social issues with private sectors. It is very difficult to uncover this intersection and hence, behavioral economics could be a lucrative option. Therefore, behavioral economics could be lucrative especially with the specification of the demand, scarcity in supply and the complexity of the intersection. In the present generation, it is nearly impossible to find lucrative work. The future might hold better opportunities for individuals looking to uncover the potential o behavioral economics.

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