What Richard Thaler (1980). But it got the attention

What is behavioural economics?

To explain observed behaviours
and market outcomes Behavioural economics applies psychological principles. It
is possibly more precisely referred to as psychology and economics’.

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In itself, the concept of
behavioural economics is not especially new, it established in 1970s/early
1980s with the work of psychologists Daniel Kahneman and Amos Tversky (1979),
and the economist Richard Thaler (1980). But it got the attention from the
public because popular books on economics and psychology such as Nudge
and Predictably Irrational,17
and by Daniel Kahneman published and winned the Nobel Prize for Economics in
2002. In recent years the theoretical, empirical and experimental literature on
behavioural economics and consumer biases has also moved on meaningfully.

At
its core, behavioural economics provides insights into individuals’behaviour. Traditional
economic models make a variation of implicit or explicit assumptions about
people’s preferences, cognitive ability and rationality. These provide the
basis for a useful, tractable framework for explaining market outcomes.

In specific, traditional models
assume that people’s preferences are reasonably free from external influence. From
own experience People regularly update their own information , moreover they
learn from their past experiences. With the final aim of maximising their
utility they also use all accessible information to make fully rational
judgements. By these assumptions, it is probable to make properly direct forecasts
about how consumers will behave based on their preferences, their budget and
the prevailing prices of different goods in the marketplace. It is not
considered necessary to explore in any detail why they make these
decisions.

But
on the other hand, behavioural economics try to assimilate theory and practice
from the psychology literature into economics. The approach has been to
identify assumptions in traditional economics that may not be realistic; to
demonstrate anomalies; and, where possible, to propose alternatives. Why people
may face a variety of problems in processing information and making decisions,
mainly the behavioural economics discuss about this.

Behavioural
economics can help to explain why search and switching costs might arise,
furthermore how consumers actually make decisions. From a regulatory
perspective, however, understanding such processes is important only as a means
to an end.

 

 

Comparing
traditional and behavioural economics

Stylised representation
of cognitive and behavioural processes involved in making choices

 

 

 

 

 

Working from left to right, basic
traditional economic models make a number of implicit or explicit assumptions
that underpin the outcomes of these models.

– Preferences do
not depend on context. Traditional models assume that, preferences are not
affected by the way in which information is presented or framed’. If the material
of the information is the same, the same decisions will be made. In short,
preferences are not reference-dependent.

– Decision-making
involves fully rational deliberation. Traditional economics assumes that, when
making decisions people use all available information  and that they are able to remember their past
experiences. It is also assumed that consumers engage in rational, conscious
reasoning to weigh up the best course of action.

– Choices over time are
time-consistent. Traditional models assume that, consumers behave in a
time-consistent way.

 

 

 

 Behavioural
economics assumptions:

– Preferences depend on
context. Preferences are reference-dependent. For example, The prospect of
a reward of €400 may be needed in order to outweigh the prospect of a penalty
of €350.22 This is called loss aversion’, or the endowment effect’.

 

– Decision-making involves
taking shortcuts. Making decision would be tiring to apply to all
day-to-day tasks. We make some decisions purely subconsciously and
automatically.

 In addition, between conscious and
subconscious decision-making lies a series of shortcuts known as heuristics’.
For example, individuals may make quick decisions based on a selection of the
information provided in the marketplace, their memories of recent experiences,
looking to what others are doing, or focusing on what they think are salient
aspects of the information. Heuristics saves a lot of time and effort, in
particular when dealing with complex problems, but can be imperfect and open to
exploitation by firms.

– Choices over time can be
time-inconsistent. Consumers can face a conflict between their short-term
urges and what would be best for them in the long term. In economics language,
their preferences can be present-biased’or time-inconsistent’relative to what
traditional economics would predictWhat is behavioural economics?

To explain observed behaviours
and market outcomes Behavioural economics applies psychological principles. It
is possibly more precisely referred to as psychology and economics’.

In itself, the concept of
behavioural economics is not especially new, it established in 1970s/early
1980s with the work of psychologists Daniel Kahneman and Amos Tversky (1979),
and the economist Richard Thaler (1980). But it got the attention from the
public because popular books on economics and psychology such as Nudge
and Predictably Irrational,17
and by Daniel Kahneman published and winned the Nobel Prize for Economics in
2002. In recent years the theoretical, empirical and experimental literature on
behavioural economics and consumer biases has also moved on meaningfully.

At
its core, behavioural economics provides insights into individuals’behaviour. Traditional
economic models make a variation of implicit or explicit assumptions about
people’s preferences, cognitive ability and rationality. These provide the
basis for a useful, tractable framework for explaining market outcomes.

In specific, traditional models
assume that people’s preferences are reasonably free from external influence. From
own experience People regularly update their own information , moreover they
learn from their past experiences. With the final aim of maximising their
utility they also use all accessible information to make fully rational
judgements. By these assumptions, it is probable to make properly direct forecasts
about how consumers will behave based on their preferences, their budget and
the prevailing prices of different goods in the marketplace. It is not
considered necessary to explore in any detail why they make these
decisions.

But
on the other hand, behavioural economics try to assimilate theory and practice
from the psychology literature into economics. The approach has been to
identify assumptions in traditional economics that may not be realistic; to
demonstrate anomalies; and, where possible, to propose alternatives. Why people
may face a variety of problems in processing information and making decisions,
mainly the behavioural economics discuss about this.

Behavioural
economics can help to explain why search and switching costs might arise,
furthermore how consumers actually make decisions. From a regulatory
perspective, however, understanding such processes is important only as a means
to an end.

 

 

Comparing
traditional and behavioural economics

Stylised representation
of cognitive and behavioural processes involved in making choices

 

 

 

 

 

Working from left to right, basic
traditional economic models make a number of implicit or explicit assumptions
that underpin the outcomes of these models.

– Preferences do
not depend on context. Traditional models assume that, preferences are not
affected by the way in which information is presented or framed’. If the material
of the information is the same, the same decisions will be made. In short,
preferences are not reference-dependent.

– Decision-making
involves fully rational deliberation. Traditional economics assumes that, when
making decisions people use all available information  and that they are able to remember their past
experiences. It is also assumed that consumers engage in rational, conscious
reasoning to weigh up the best course of action.

– Choices over time are
time-consistent. Traditional models assume that, consumers behave in a
time-consistent way.

 

 

 

 Behavioural
economics assumptions:

– Preferences depend on
context. Preferences are reference-dependent. For example, The prospect of
a reward of €400 may be needed in order to outweigh the prospect of a penalty
of €350.22 This is called loss aversion’, or the endowment effect’.

 

– Decision-making involves
taking shortcuts. Making decision would be tiring to apply to all
day-to-day tasks. We make some decisions purely subconsciously and
automatically.

 In addition, between conscious and
subconscious decision-making lies a series of shortcuts known as heuristics’.
For example, individuals may make quick decisions based on a selection of the
information provided in the marketplace, their memories of recent experiences,
looking to what others are doing, or focusing on what they think are salient
aspects of the information. Heuristics saves a lot of time and effort, in
particular when dealing with complex problems, but can be imperfect and open to
exploitation by firms.

– Choices over time can be
time-inconsistent. Consumers can face a conflict between their short-term
urges and what would be best for them in the long term. In economics language,
their preferences can be present-biased’or time-inconsistent’relative to what
traditional economics would predict