Behavioural economics
Homo economicus/Econ
"Standing alone, with money in his hand, ego in his heart, a calculator in his head and nature at his feet. He hates work, he loves luxury and he knows the price of everything." - Economist Kate Raworth
Human behaviourl
"Humans"
not rational
collaborative
complex
less calculating
compassionate
utility maximising
People are more likely to act like economic man when they learn about economics
Damages society
"our wants change as our values do"
Choices
scarce
unlimited needs and wants
limited resources
the more choices, more opportunity for the consumer´s satisfaction
rarely want to maximise utility
Rationality In Economic Models
rational behaviour
perfect information
Maximise utility at all times
limitations of rational choice
dual process model
system 2
System 1
very active
reacts to environment
conscious
reasoned
deliberate
requires mental work
stand by state; called upon
economic models says people are guided by system 2
Able to make decision making efficient
with
impressions
intuitions
feelings
tends to do predictable mistakes
Limitations of human rationality
Bounded rationality
Imperfect Information
Usually it is difficult to be able to compare and analyse all choices available
Time constraints
limited time for decisions
very time consuming to analyse all prices and data from all the products
Consumer is rarely able to evaluate choices effectively
Cognitive limitations
"humans are predictably irrational" - Dan Ariely
behaviour deviates from the assumptions of economists in predictable ways
Bounded Self-control
Consumer may cause marginal utility to gradually become negative
Knows how to maximise utility
how much to consume
what to choose
Will maximise total utility when marginal utility is zero
"consumers are aware of when the marginal utility of consuming one more unit is zero"
Consumer is unaware of marginal utility values
Humans value present more than future
leisure at expense of negative consequences (hyperbolic discounting)
more likely when there´s a huge range of time between choice and consequence
preference are consistent over time, not always true assumption
Bounded Selfishness
Humans are concerned with maximising their own utility
theoretical models ignore concerns for others
studies show that human are generally social, caring and cooperative
we cooperate as long as others do (conditional cooperators)
people who studies economics exhibit more selfish behavior than those who didn´t
believe behavior is acceptable
decisions based on true and/or complete information on alternative choices.
clear preferences for goods and services
stable over time
transitive
If consumer prefers apples to oranges, and oranges to banana, he must prefer apples to bananas
highly developed analytical skills
know what they prefer
can compare possible choices
based on costs
based on utility
MORE CHOICE
more utility
automatic, effortles, not controlled thinking
turns impressions, feelings, etc, into beliefs that guide actions
Cognitive biases (Irrational behaviour)
Rules of thumb
accurate principle
term comes from the ways the thumb has been used for lenght estimates
Heuristic
heuristic
Anchoring heuristic; strategy to make guesses about things one doesn´t know
Foundation of behavioral economics
Amos Tversky
Daniel Kahneman
Richard Thaler
mistakes from system 1 causes behaviours that seem irrational to System 2 thinking
practical method, not particularly rational (mental shortcut)
people may not come with an accurate estimate (anchor not adjusted enough)
people are always affected by anchors, even when there´s no relation
Reacts rationally in reaction to price changes according to the law of demand
consumer´s willingness and ability to pay is affected by anchoring
e.g. when consumers are in unfamiliar market situation
no idea of how much to pay, so business sets high anchor price
Framing heuristic
decision and thinking affected by the way in which problem is framed
e.g. Disease Problem
participants asked to asses two proposals for how to cure a disease: one framed in % of people that dies; two, percentage of people who would live
people choose second proposal bc expressed in positive terms
irrational response
Availability heuristic
People recall similar events from available memory to answer a event´s probability
events affect thinking, especially risks
the more easy to recall events, more common an event would be
In Action
Choice architecture
way choices are structured for consumers
Physical positioning of product
language used to present choice
sequencing of various choise and range of offerings
consciously structure by
governments
businesses
other organizations
high impact on human decision making
Default choice
an option is automatically set for consumers
option can be changed if its wished
Purpose
no clear preference/ did use System 2, so choice is made for them
choice should maximise utility
Restricted choice
consumer choices are limited
reducing the number of options can help consumers make better decisions
Mandated choice
better chance of consumers making decisions
organization forces consumer to make decision at a defined point in time
reduces chance of procrastination on choice
weighing uo options that could have been put off into the future
Nudge Theory
how choice architecture can be crafted to make use of the cognitive biases
better choices in lives
arrangement of choice architecture that alters people´s choices
w/o limititing choices
w/o changing incentives
Businesses
seek profit maximisation
want to increase revenues
reduce costs
Owners/shareholders earn largest possible return on original investment
entrepreneurs are given profits
profits work as an incentive for investment in new businesses
profits are used
to fund research
development
to find new market
maintain competiveness
Wages can be tied to profit
extra incentive
must be profitable
goals
Corporate social responsibility (CSR)
Firms should and will take responsibility to look after stakeholders
may involve higher short-term production costs
higher wages
environmental friendly equipment
avoiding pollution
spending in research and development
circular production
keep materials in use for as long as possible, contrasts "we take-make-waste"
Growth and market share
large profit in the long run
market share: percentage of a market that a firm control
quickly growth
able to gain major market share
monopoly
by merging with other firms
aggressive pricing strategies
other smaller firms can go out of business
process may result in lower profits in the short run
attractive to investors
greater profits in the long run
large revenues
dominance in the market
economies of scales
less production cost when firm grows in size
Satisficing
satisfying policies that don´t offer maximisation (low profits)
e.g. Owner of a small business wants to keep work-life balance
less than required work to maximise profits
no agreement signed
completely rational