Empowering People through Behavioral Science

Behavioural economics for better decisions

By Olivia Willis -- ABC

Humans 'misbehave'—we're irrational, indecisive and passionate, yet conventional economics assumes that we will always act logically. Can using a more realistic understanding of human behaviour nudge us to change our way of thinking? 

As Mary Poppins once famously sang, 'a spoonful of sugar helps the medicine go down!' So goes the logic of behavioural economics: if you want to encourage someone to do something, make it easier for them.

'Figure out what the barriers are that are preventing somebody from doing something, and remove them,' says Richard Thaler, a professor of Economics and Behavioural Science at the University of Chicago.

Thaler is known as one of the founding fathers of behavioural economics, the field which combines recent discoveries in psychology with a practical understanding of incentives and markets. As such, the professor investigates the interplay between economic theory and the psychology of irrational human behaviour.

'Economists model creatures that are hyper rational, have no self-control problems, no emotions and are extremely selfish,' he says. Behavioural economics is 'really just economics with people instead of these fictional creatures that pop up in economics textbooks.'

Thaler's interest in behavioural economics was sparked by a psychology paper he came across while a student at university. The paper, written by psychologists Amos Tversky and Daniel Kahneman, demonstrates how people make judgements based on their estimations of probabilities or quantities.

The authors made two points. 'One is that we use simple rules of thumb to make those judgements. We can't calculate everything,' he says. 'The second is that using those simple rules of thumb leads to systematic error.'

According to Thaler, the concept of 'anchoring' explains this phenomenon.

'Suppose I ask you whether the population of Chicago is more or less than five million people, and then I say, okay, what is the population of Chicago?' says Thaler. 'You're likely to give a higher answer than if my first question had been, 'Is the population of Chicago more or less than 1 million?', because you will anchor on that first number and then adjust.'

He believes the paper was significant to the evolution of economics, because it concluded that humans are neither as smart nor logical as the pseudo-humans upon which conventional economics rely.

'[Economists] thought, okay, they make mistakes but they average out. But what Kahneman and Tversky's research showed is no, they don't wash out, the mistakes are all in the same direction,' says Thaler.

'And that was like a big idea for me.'

Soon, he began to find human idiosyncrasies everywhere he went. He then started a list of what he perceived as 'funny' or irrational human behaviour in an economic context.

'Suppose there's a big cricket match in Australia and somebody is given two tickets and you ask them, "Well, how much would you demand togive up those tickets?" And they'll say, "Oh, $300.' And then you say, "Well, how much would you be willing to pay to get those tickets?" ''Oh, $150.'''

According to conventional economics, that's considered 'misbehaviour'.

Behavioural economics says that if you own something or you are somehow invested in something, you inherently attribute more value to it.

'I ended up calling this the endowment effect, because in economics we refer to things you own as part of your endowment, and we value the things we own more than the things we don't own. And this creates a lot of status quo.'

To Thaler, this phenomenon also explains our love of junk. 'We all have stuff lying around the house that we'd never think of paying any money to buy, but nevertheless we don't get rid of it.'

Humans appear to be more challenged by the prospect of losing something than the prospect of gaining something of the same value.

Thaler believes that the key to understanding economics — and indeed the world more broadly — lies in our ability to understand human behaviour, rather than counterfeit human models.

'I study humans and other economists study "econs". And if we really want to understand how the world works then we have to shift our attention to humans, and that's true for virtually any problem,' he says.

'Just think about what's been going on in the stock market. It's pretty hard to think that this is a bunch of highly rational, unemotional people that are trading in these markets.'

Whilst the idea of humans behaving without logic or rationale is hardly surprising, over time, Thaler believes that economic theory has become increasingly mathematical in its attempt to be more scientific. This, he says, has come at the expense of how realistic it is.

' The behavioural economics revolution is really to say, "Okay, we can do maths but it's going to be harder maths because we have to incorporate these human features as well as the automaton behaviour that economists usually study".'

Taking on this idea, Thaler published a book on behavioural economics called Nudge: Improving Decisions About Health, Wealth and Happiness. Incorporating behavioural economics, he uses the concept of 'nudging' as a technique to steer people's choices, and help them make better decisions.

'A nudge is any small feature in the environment that attracts our attention and influences our behaviour,' says Thaler.

Perhaps the most infamous example of a nudge, he says, is to be found in the Amsterdam International Airport. 'Some genius etched the image of a house fly near the drain in the men's urinals,' says Thaler. 'And the airport claims that spillage was reduced by 80 per cent. It seems if you give men a target, they will aim at it.'

Not just for pee control, some governments are employing dedicated 'behavioural insights departments', employing behavioural economics to inform policy. Thaler has served on such departments for the US and British governments.

'One of the ways we can nudge people to help make better decisions is just to make the good decision easier,' he says. For example, using default settings that encourage people to make wiser choices. He cites retirement savings plans in the United States as a success story.

'In the US there are defined contribution retirement savings plans that are voluntary,' says Thaler. In the past, employees were required to fill out a bunch of forms if they wanted to join. 'Then employers got smart and started switching to default,' he says. The default being: you're in the savings plan, and if you don't want to join, you have to fill out a form.

'Enrolments go up to about 90 per cent.'

While Thaler and his colleagues endeavour to 'nudge for good', he admits the same techniques are often used in the private sector for commercial gain.

'If you fill out any form there are going to be pre-check boxes, and a good question to ask is... "are the boxes best for the customer or best for the firm?" And all too often we see that the preselected boxes are the ones that are good for the firm.'

Thaler says that while a moral dimension will always exist, his work with governments is ultimately about finding the best outcome for people.

'We are recognising that people are lazy and that they take the easy way. So we make the easy way better.'

 

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