What is Behavioural Economics?
Behavioural Economics is a field that has grown explosively over the past 40 years. In simplicity, it seeks to expand the classical economic model of a human as entirely rational to take account of the fact that humans are frequently and meaningfully irrational too. Drawing from fields such as psychology, anthropology, neuroscience as well as a wealth of original experimental work. Behavioural Economics is becoming a powerful way of understanding how people behave economically. GMT+ brings this growing wealth of research to your business and can help you apply to manage your customers, staff and competitors.
Perhaps the most powerful idea to start with in order to describe Behavioural Economics is the idea that mental resources are finite instead of boundless. Limited mental resources mean that the mind cannot think deeply and carefully about everything it is presented with. Instead the mind must pick what it gives a lot of energy to, what it only gives a little energy to, and what it ignores altogether.
Thinking that takes a lot of energy is thinking that is slow, deliberate and which carefully checks itself for errors. This way of thinking is the sort of thing people will have in mind when they say “let me think about this”. This is the sort of thinking we do when we are endeavouring to be rational such as when we are completing a bond application, or taking an exam. This type of thinking however requires a lot of effort, to the extent that it can leave us feeling tired afterward. Not all thinking can be done this way and mostly, it isn’t. Another type of thinking is fast, almost instinctive thinking which does not check itself for errors.
This type of thinking uses relatively little energy. This is the sort of thinking we do when we drive, cycle, eat, browse the web, make conversation, make a meal, do a routine task and much else in everyday life. It is the sort of thinking that is largely responsible for filter. Fast thinking avoids getting paralysed by over-analysis and helps us get things done. This is how we do most of our thinking and it is where Behavioural Economics comes into its own.
Fast thinking is fast because it takes shortcuts. Like a sneaky runner or a dubious derivatives trader the fast system instead of running the long, true, righteous course prefers to take shortcuts and to take them wherever and whenever possible. These mental shortcuts can approximate the result of deliberate thinking at a fraction of the mental cost. However, they can also just as easily produce results that are anywhere from slightly irrational to totally weird.
Understanding these shortcuts, what they are, when they are used and how they influence the economic behaviour of people is the job of Behavioural Economics. There are many sorts of shortcuts that the mind uses when thinking fast. In the weeks, months and years to come we will look at each of these and others in some detail in our blog. For the moment we will briefly highlight four major types of shortcuts: salience, other people, risk and time.
Salience
Perhaps the most straightforward shortcut to appreciate is that the mind focuses on that which is salient. The mind seems to give its attention to that which is most noticeable rather than that which isn’t. And this has consequences. From preferring a few options, to a cluttered menu, to posting something outrageous on Facebook in the search for likes, each of us has an appreciation for this truth. What we make salient also influences actions. By reporting costs of a payday loan upfront, experimenters were able to reduce uptake of payday loans by 11%. Managing what is salient to the fast thinking systems of your customers, staff and competitors is an important ingredient in managing your business.
Other people
One the major ways in which the mind takes a shortcut is to look at what is happening with other people instead of thinking things through for itself. Large crowds, small groups and even individuals can provide cues to the mind which it will take and use instead of thinking things through for itself. In everyday life we may conform strongly to certain social norms in efforts to be polite, while instinctively steering clear of others to differentiate ourselves from the crowd. In terms of our style choices, whether we see ourselves as hipster, hip-hop, goth, wasp, or entirely individual it may be that nothing determines what we spend our clothing money on more than social style norms. When looking for a good restaurant in a strange city we’re likely to pick one that is full over one that is empty without further consideration. In many other situations we find ourselves following the lead of the herd, or finding it hard not to. Finally, when we’re observed by at least one person we tend to behave a little better than when we’re completely alone. There is a wealth of research into all sorts of ways in which other people influence us – from social norms to signalling – but the point is that the mind frequently reacts to other people rather than taking the time to puzzle things out for itself.
Time
In all sorts of situations time matters. It seems that our brains prefer things now much more than to things in the distant future and follow shortcuts of this nature. Perhaps this made sense on the uncertain savannah when all sorts of predators could end one’s life that very day. Ask anyone who has ever made a New Year’s resolution, or had to study for an exam and they will acknowledge that the time between making a decision to do something and actually doing that thing can make a great difference. The procrastination that is so sweet now is the very thing we bitterly curse as the deadline hits. Pension schemes have worked with this shortcut to increase sales by getting people to commit to something they think is good now (saving for retirement) but moving the pain of paying later in the future by getting people to sign a debit order that activates from next month’s pay-check not right now. Knowing how to work with our time shortcuts can help your business… and your customers.
Risk, losses and gains
People frequently respond more instinctively to risk than rationally. For starters, we really struggle to perceive the true risk of something, with the result that we have whole populations that avoid the sea for fear of sharks but are happy to run the risks of driving. We also tend to adopt more desperate measures to prevent a loss than lock in a gain. Rogue traders trying to trade their way out of concealed losses while they face slimmer and slimmer chances of success rather than cutting those losses earlier on are extreme examples of this. You can minimise risks to your business by understanding how your customers, staff and competitors think quickly about risk themselves.
Behavioural Economics has exploded over the past 40 years and has in that time made great strides in understanding how people actually behave, in their moments of rationality and irrationality. It now offers a powerful set of tools with which to understand and get the most from your business, wherever people are involved.
Note: As the weeks, months and years go by we will be writing about the (many, many) various topics within Behavioural Economics in more detail; at times reporting on new research, or reviewing established work and not infrequently looking at current affairs through the Behavioural Economics lens. We will be doing this on this blog, and it will all be happily filed under the Behavioural Economics category.
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