The economics of the mind: An introduction to behavioural economics

Think about the last time you traversed in public. If this area were clean, you would be much less likely to litter. However, if your environment was dirty, most people would be fine with following suit. This is an example of the flourishing field of behavioural economics.

Behavioural economics is an emerging sub-field of economic theory, which relies on psychological experiments to construct its basis. We like to think of ourselves as a rational species, but the reality is we make irrational decisions based on emotions. It has demonstrated remarkable outcomes, challenging aspects of traditional economic theory. The field was pioneered into existence, by two economists, the late Amos Traversky, and Nobel laureate Daniel Kahneman.

The duo introduced two fundamental theories to the discipline, namely the “availability heuristic” and “prospect theory”. Simply put, the availability heuristic dictates that the human brain relies on information that comes to mind easily, to make decisions. For example, people may fear tornados as a common cause of death if they had recently read about one such casualty, but these incidents are quite rare.

Through prospect theory, the pair demonstrated the effects of framing and loss aversion on the decisions people make. Framing highlights the importance of the portrayal of a task in an individual’s decision-making process. The most famous example of this is Mark Twain’s story of Tom Sawyer whitewashing the fence. By framing the chore in positive terms, he got his friends to pay him for the “privilege” of doing Tom’s work.

Loss aversion deals with our tendency to alternate between being risk-averse and risk-seeking, depending on the situation. For example, if one is asked to choose between outcomes that have a 100% chance to win 250$ or a 25% chance of winning 1000$ and a 75% of chance of winning nothing, most people would choose the former option. However, if asked to choose between a 100% chance of losing 750$ or a 75% chance of losing 1000$ and a 25% chance of losing nothing, most people would prefer the latter.

Shortly after them, economist Richard Thaler’s contributions to the field were published in “Nudge: Improving Decisions about Health, Wealth, and Happiness”. Thaler is most famously known for introducing the concept of a “nudge” into contemporary economic theory. At its core, a nudge is a carrot used to help people make better decisions. Presently, nudges are being implemented everywhere, without our knowing. For example, placing fruit at eye level or near the cash register at a high school cafeteria helps students choose healthier options.

Behavioural economists are trying to highlight our biases and the role they play in decision-making. They hope that these insights will result in more effective policymaking. This rapidly expanding field continues to attract attention, and several bystanders (including me) believe there is more to come.