Most economic theories are based on the assumption that individuals act in rational ways. Rational decision-making depends on choosing the option that brings the greatest benefit to the decision maker. These theories assume that rational people are capable of self-control and do not make decisions based on feelings and external factors. Economics contrasts with this view, as it shows that individuals are not rational and cannot make perfect decisions in all situations and situations, and may even make decisions which are not in their personal interest.
Now the question comes to our mind:
How do we distinguish between rational and irrational decisions?
For example, if Glory wants to lose weight and has the necessary information on the number of calories per food, he will choose only the lowest calorie foods so his decision is rational. Behavioral economics, even if glory wanted to lose weight and made a plan for it; His final behavior tends to distort his perceptions, feelings, and social influence. For example, if a brand of an ice cream company appears in a television advertisement with a competitive price, the advertisement will display a statement as follows: A person needs 2,000 calories per day to effectively perform their daily activities, so here is the image of the ice cream, the price, the statistics mentioned in the advertisement, greatly affecting On the temptation to drop ice cream and withdraw from a weight loss program, demonstrating that he lacks control over his behavior, which is considered unreasonable, and in fact is happening. every day.
if ; What is behavioral economics?
Behavioral economics combines psychology and economics to explore why we sometimes make irrational decisions, and how and why we act differently than economic theory predicts. Economists generally aim to develop models of human behavior and individual interactions in various economic situations in an effort to predict economic outcomes, but we – as human beings – act in complex and sometimes unpredictable ways, and despite our attempts to make rational decisions, our cognitive abilities are limited, and our willpower can to betray us. Sometimes the other side of us is also concerned with moral values, such as equality and justice, and self-interest is what drives most of our decisions. Moreover, our awareness and self-control motives can vary from person to person in society. The 2017 Nobel Laureate (Richard Taylor) has been instrumental in the development of behavioral economics for the past 40 years; It provides this insight by bringing together ideas from human psychology and economic analysis. The field’s basic and practical concepts contribute to a more realistic explanation of individual economic behavior; When he moved from the side sphere to the main sphere of the economy.
But what new thing did (Richard Taylor) add to winning the Nobel Prize?
Taylor did not discuss the issue of individuals behaving irrationally when making decisions; Because it was already clear, his real contribution was that he showed that when individuals act irrationally, it was in a consistent manner and a certain pattern, and thus their irrational behavior could be predicted, placed, and modeled economically. First, he concluded that economic decisions are affected by three psychological aspects of the individual:
Considering these aspects separately, we will divide his contributions into these three aspects.
- The first contribution:
focus on the first psychological aspect related to the limited perception of the individual, the most prominent result being the so-called “gift effect”; It expresses an individual’s tendency to value what he has for his own worth; One group of students conducted an experiment in which a group of students was randomly given cups of coffee and then asked if they would sell them to a second group of students who did not get the cups. Take the cup, which can be interpreted as one’s pain for losing something is greater than his satisfaction when he gets the same thing; The psychological impact of a loss is greater than the effect of profit. He came up with a concept called mental accounting, which showed that people simplify their economic decisions by creating separate financial accounts in their heads, and making individual decisions based on the impact of those decisions on each account, rather than on the sum of personal assets, but how that would affect their decisions Economic? for example ; Most people divide their monthly income into several parts, part of which is for household expenses, part for vacation, part for saving, etc. Due to the separation of these parts, individuals tend to borrow an amount of money for their own needs. Necessary needs rather than spending part of the savings, which will be reflected in it at an additional cost. “Mental accounting” includes another point where we, as individuals, set a reference point for making economic decisions, and this reference point may be price, perhaps even the lowest available price. for example ; Suppose a consumer wants to buy a watch and knows that there is a store nearby that sells the same watch for $100 less than the store of his choice, then if the watch has a price of $1,000, he will go to the cheapest store to buy it, but if the watch costs $10,000, he will not go to the cheapest store , but why? This is because the individual sees the subject as a percentage and the price acts as a reference point, although it makes sense to accept the $100 savings in all cases. Another example: economic theory says that when gas prices are low, people will use their savings for more urgent needs, and there will be no more gas, but in reality people will spend more money on gas; That is, they believe that part of their income goes to gas, which they will continue to consume regardless of their needs.
- Second contribution:
Focus on the second psychological aspect related to self-control. The problem of lack of self-control prevents individuals from making rational decisions even if they know it. One of his most important achievements in this regard is the “Planner-Doer” model. The model is based on measuring the resulting internal tensions with regard to short-term actions (Doer) and evaluating options based on current benefits derived from them, as well as long-term planning (Planner), which focuses on reaping the greatest benefits in the long term.
One of the main reasons for the failure of our long-term plans is to succumb to the temptation to make short-term gains, for example, when a person chooses to get $100 now or $120 in 3 months, the greater proportion will decide to get the amount now. Although the rational decision is to get a larger amount in the future.
- Third contribution:
Focus on the third psychological aspect related to social preference; Because social preference is critical to an individual’s decision-making process, Thaler designed and implemented a controversial laboratory experiment to measure social preference, known as the Dictator’s Game. This experiment is based on choosing two people and giving one of them two options:
First: Dividing the amount of $20 equally with the other party
. Second: give him $18 and $2 for the second party.
It turns out that the largest proportion of people will choose the first option with some exceptions, and in the second stage of the experiment, one of the split subjects will choose one of the following two options:
The first part of the person who received 2 dollars.
Second: Divide the $12 equally among the person who earned $18 in the first part of the experiment.
Most people choose the first option and decide to lose a dollar as punishment for what they see as greed and injustice, although the second option seems logically more appropriate; That is, justice is done for the individual. consequences; People punish those who wrong them, even if the unfair behavior doesn’t affect them personally or if their unfair behavior doesn’t change anything, which explains why a department store, for example, chose not to raise prices during a heavy rainstorm, and would lower wages Workers are in recession, according to traditional economic standards, until they reach levels consistent with demand for goods and services, which means that the recession will not lead to job losses, but workers see cuts as unfair and as a result, employers will reduce the number of workers rather than wages ; This justifies the unemployment that occurs during recessions. Richard Thaler is co-founder of Behavioral Finance with Robert Shiller, who analyzes how investor psychology influences his decisions, and thus prices in financial markets.
How are these contributions used in practice?
Richard Thaler’s 2008 book NUDGE caught the attention of public policy makers; The book showed how countries can use behavioral economics to improve their economic efficiency; The way choices are presented can easily lead people to make better decisions. Public policy makers in many countries, including Denmark, France and the United Kingdom, have used the writers’ advice, and (David Cameron) created a program called “NUDGE”. UNIT “was initially promising to use this aspect of public policy. One such experiment would be to send a message to someone who owes car taxes, but in a different way, for example: colloquially, “Pay the tax or you will lose your car.” The number of taxpayers doubled in case Single and tripled with the addition of photos.
(Richard Thaler) greatly contributed to the increase in investment in pension funds because, based on his findings in behavioral economics, people often choose the default option when filling out a formal application, rather than the default option “Pension Fund” check mark Or a mistake with an empty square, the option next to it became the real flag by default, so that the user could change it, which led to a huge increase in the money invested in pension funds. At the level of private companies, companies are now trying to use behavioral economics to increase sales,
For example: in 2007 the iPhone 8 GB was priced at $600, then the price dropped to $400 soon after, but if the fair value of the phone was at how about $400 by no means released at that price? This may cause a negative initial reaction to the device in the smartphone market, where people think the phone should be expensive, but when the phone is offered at a higher price and then the price is lower, consumers think they are getting a very tempting offer. ; Because they can buy a $600 phone for just $400, which has led to Apple’s massive sales increase . In the end ; It can be argued that these contributions built a bridge between psychology and economics, led to amazing applied results in this field, and stimulated research and development in the field of behavioral economics.