What is... | August 10, 2012

What is behavioural economics?

Standard economics typically assumes people make rational decisions; behavioural economics brings psychology into the equation.

Behavioural economics is about how people actually behave rather than how they would behave if they were perfectly rational – examining those irrational tendencies that see us falling for "special" deals in store, investing with the “herd”, being reluctant to sell losing investments and more. The field has risen in prominence in recent decades, with books Freakonomics, Nudge and Predictably Irrational hugely popular.

Not so efficient
Mainstream economics could be characterised by the efficient markets theory. In 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 they “should” borrow rather than the maximum they can borrow.

Likewise, renowned economist Robert Shiller said in an August 2012 interview that “learning amazing things" about human behaviour will change thinking about the economy.
Governments are also getting on board, with the UK government’s behavioural insights team testing if nudges can boost tax repayment rates and more.

Pulling the purse strings
ING 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” of how choices are framed – may encourage better savings habits and lead to better retirement planning.

InvestingEconomicsSavingDan ariely

eZonomics team
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