Beyond the Rational - Behavioural Economics

For centuries, economic theory was built on the model of Homo economicus—a perfectly rational human who always makes decisions to maximize their benefit. But let's be honest, does that sound like anyone you know?

Behavioural Economics is essentially this - a fascinating field that blends insights from psychology with the principles of economics to understand how people actually make decisions.

In a nutshell, behavioural economics is the study of why people make irrational choices. It challenges the old model by showing that our decisions are systematically influenced by cognitive biases, emotions, social norms, and mental shortcuts known as heuristics. These mental "glitches" mean we often act against our own best interests, according to ideas of optimisation, even when we know better.

The Field, popularised by psychologists like Daniel Kahneman and Amos Tversky, identifies common patterns of irrationality and creates more fitting theories based off observed human behaviour than traditional economics.

For example:

The Status Quo Bias: We have a strong tendency to stick with the current situation, even if a better option exists. Think about never switching your energy provider despite potential savings.

Loss Aversion: We feel the pain of losing the one quantity much more intensely than the pleasure of gaining the same. This makes us overly cautious in comparitively harmless scenarios

Anchoring: We rely too heavily on the first piece of information we see. That's why a discount sales tag works so effectively—the original price "anchors" you to perceive the discount as a great deal even if the original price was infeasible in the first place.

"So why is behavioral econ important?"

For Economics: It Replaces a Flawed Model with a Realistic One

A model that assumes perfect rationality will often make wrong predictions. By incorporating how people actually behave, behavioural economics creates models that are messier but far more accurate in predicting real-world outcomes.

Furthermore, Behavioural economics shows that the design of the choice is often more important than the information itself. This led to the rise of nudges, a subtle way to influence people's choices and steer them toward a particular decision without taking away their freedom to choose, leading to increased government implementation around the world, which have proven highly effective at improving outcomes in health, finance, and safety at a low cost.

In short, for economics, behavioural economics is effective because it injects a dose of realism, transforming the field from a theoretical idea of human behaviour into a practical tool.