What is... | August 10, 2012

What is behavioural economics?

Standard economics typically assumes people make rational decisions. But behavioural economics brings emotion and thinking traps into the equation – examining those irrational tendencies that see us falling for the special deals in store, investing with the “herd”, being reluctant to sell our losing investments and more.

Behavioural economics is said to be the study of how people actually behave rather than how they would behave if they were perfectly rational. The field has risen in prominence over the last 20 years, with books Freakonomics, Nudge and Predictably Irrational hugely popular.

Not so efficient
Standard economics could be characterised by the efficient markets theory. Under this idea, public information is priced into share markets, meaning shares trade at their fair value.
Behavioural economics says emotion plays a role – with fear, greed, overconfidence and herd behaviour among the tricks and thinking traps. ING global chief economist Mark Cliffe challenged the efficient markets theory in his fifth video lesson for investors from the financial crisis and said that fear and greed during the crisis “presented many bargains to be snapped up by expert investors”.

Now governments are getting onboard
Academic and Predictably Irrational author Dan Ariely blogs in three questions on behavioural economics that lessons from behavioural economics could be used to improve policies and tools to help people make better decisions. Ariely gives the example of telling prospective mortgagees how much the “should” borrowing rather than the “maximum” they can borrow.
Likewise, renowned economist Robert Shiller says in an August 2012 interview “learning amazing things about human behaviour” is going to change thinking about the economy.
Governments are also getting onboard, with the UK government’s behavioural insights team testing if nudges can boost tax repayment rates and more.

Pulling the purse strings
eZonomics aims to combine ideas around financial education, personal finance and behavioural economics, demonstrating how the theories apply to real life.
Blogger and economist Chris Dillow highlights, for example, the way the endowment effect makes us reluctant to sell loss-making investments, why we back long shots against the odds, how some generations become more averse to risk and more.
The What is … section defines many terms, including availability bias, hyperbolic discounting, mental accounting, the gambler’s fallacy and the status quo bias.
Nudges – or the “decision architecture” around the way choices are framed – may encourage better savings habits and lead to better retirement planning.

InvestingEconomicsSavingDan ariely

eZonomics team
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