Behavioral economics, also known as behavioral economics, focuses on analyzing why, when making economic decisions, people are not entirely rational, but are influenced by psychological, cognitive or social elements.
Behavioral economics can manifest itself in many cases. For example, when a person considers buying a certain product, it is quite common that he/she does not get to learn about each of the options and features, since he/she will buy the one that a person close to him/her uses or recommends.
Also, when an individual is thinking of buying products from another company that he/she usually trusts, he/she tends not to do so if this decision has any consequences. This is often the case with businesses that incorporate loyalty cards, since many consumers will prefer to continue with their purchases so as not to reject the benefits of the card.
Another example of behavioral economics can be found in the good treatment of customers by the salesperson in a store. Buying products provides very short-term satisfaction, so that positive attention (pleasant behavior or details from the store when buying, for example) has a much greater influence on the customer, who will become loyal to the store and recommend it because of the good experience.
Negative feelings and behaviors towards the customer also play a very important role in this aspect. For example, if a salesperson stops attending to a shopper in the middle of a conversation to answer a cell phone, the latter will feel indifference and lack of attention, so it is very likely that he or she will leave the establishment and make purchases in another store.
Behavioral economics studied by Daniel Kahneman and Richard Thaler (Nobel Prize in economics)
When delving deeper into the field of behavioral economics, two important and recognized theories stand out, that of Daniel Kahneman and that of Richard Thaler.
Daniel Kahneman’s view
Daniel Kahneman’s theory focuses on the existence of two cognitive parts:
- The first of these is characterized by possessing an irrational nature, and by the influence on a large part of the decisions made in day-to-day life.
- The second, unlike the first, is rational and focuses on studying irrational thoughts in order to make decisions.
For decision making to be as adequate as possible, there must be a rational and an irrational part, i.e., the two cognitive systems must be compensated and balanced.
The vision of Richard Thaler
Richard Thaler has been recognized with the Nobel Prize in Economics in 2017. His theory about behavioral economics is based on the fact that, on many occasions, people are not able to make the right decisions, so they need an incentive that Thaler calls a “nudge” to help them do so.
An example of this theory is the way products are distributed in a supermarket. If you want to encourage the population to consume certain goods, they will be placed strategically so that they are seen immediately, exerting that push that helps them when making the final purchase decision.
So, don’t individuals make decisions rationally?
In classical economics, it has been interpreted that individuals make decisions in a totally rational manner. However, given the contributions of behavioral economics, it has been shown that, in most cases, this is not entirely true, since psychology plays a fundamental role in decision making.
In many situations, people do not choose what would end up being more convenient, since certain preferences and restrictions are involved that make the final decision one or the other.
Its psychological impact on today’s economy
Traditionally, within the investment field, it has always been assumed that people spend money based on rational thinking. Studies on behavioral economics have shown that many decisions are conditioned by personal factors and the risk one is willing to take, as well as by certain socioeconomic aspects.
Thanks to Thaler, a change has been observed in the perception of the economy and in how individuals make decisions. He showed that people have very influential priorities when making a large part of their decisions, limiting rationality and showing a clear lack of self-control by a large part of society.
Controversies within behavioral finance
Although Richard Thaler received a Nobel Prize in Economics for the contributions made in his theory, there are economists who do not entirely agree with what it states. One of them was Merton Miller, who stated that, although it is true that on many occasions psychology influences decision-making, it is not an aspect of great importance in finance.
Behavioral finance has always been a concept that has been much discussed and criticized by many branches of economics. Despite the arguments made by these individuals, there is no doubt that a large part of decisions are influenced in some way by cognitive, social or psychological factors.
Behavioral economics believes that the decision-making process is influenced by aspects other than rationality. This has been supported by the theories of authors such as Daniel Kanheman and Richard Thaler, although there are also numerous criticisms of this thinking.