By Ekanshi Makheja, Deputy Editor
Introduction to Behavioural Economics
People think Behavioural Economics is a relatively new field of economics, yet the first-ever behavioural economist happened to be Adam Smith! The core assumption of neoclassical economics is that agents choose by optimising their decisions based on predefined constraints, but it wasn’t always that way, Economics started behaviorally.
It can be inferred from Adam Smith’s writing which emphasised on topics that behavioural economists talk about today. For example, Loss Aversion: ‘pain, is almost in all cases a more pungent sensation than the opposite and correspondent pleasure’ [1759] and Overconfidence: ‘the overweening conceit which the greater part of men have of their own abilities’ [1776], to quote a few topics.
The agents that neoclassical economics talks about – who Always choose by optimising and actually decide their spending according to the life cycle hypothesis- are certainly not humans. Nobel laureate Richard Thaler calls them ‘Econs’ and contrasts them with actual humans and says that the core of behavioural economics is to find how big the disparity is between econs and humans. Behavioural economics revolves around theories of nudges, mental accounting, biases, heuristics, sludges, to name a few, and this article explores the most basic aspect of Behavioural Economics , i,e the Nudge Theory.
What are Nudges?
Nudges are simply small features in the environment that influence our behaviour. They are interventions designed to encourage individuals to make choices that are in their best interest while still preserving their freedom of choice. A tax isn’t a nudge. A subsidy isn’t a nudge. A mandate isn’t a nudge. And a ban most certainly isn’t a nudge. A warning however, is a nudge: “If you swim at this beach, the current is high, and it might be dangerous.” You’re being nudged not to swim, but you can. Nudges are particularly effective because they acknowledge the limitations of human attention; they help individuals focus on important information amidst the multitude of distractions in daily life. A nudge can get us to pay attention.
What are choice architectures?
Any situation where you’re making a choice, has an architecture to it. The owner of a website may apply a very large font to certain things—the things that the private or public institution really wants you to attend to and maybe choose—and keep certain things hidden in small print at the bottom, let’s say a service tax of 10% written at the end of the menu at a restaurant.
An example of this is a program in the United States aimed at ensuring children from low-income families have access to school meals. Although these children are legally entitled to these meals, many parents don’t sign them up, possibly due to the intimidating process, confusion, or lack of time. The government addressed this issue by transitioning from an opt-in to an opt-out system. Under the new system, if a child is identified as being from a low-income family, they automatically receive the meal without the need for parents to sign up. This simple change, requiring no extensive advertising campaign, has resulted in 15 million children across the US now benefiting from nutritious and delicious meals at school.
Thus, choosing the right choice architecture is essential for maximising welfare. If you have a choice architecture where people must opt in, for instance, the participation rate is a lot lower than if the architecture prompts them to opt out.
Nudges vs Sludges
A slightly related term to nudge is sludge. You can think of sludge as ‘the evil cousin’ of nudge, “It’s like erecting psychological fences.” Let’s say you purchased a book from a website. In the process, you somehow ended up signing up for their newspaper subscription. When you eventually realised your mistake, you went back to the website and were relieved to see the option: “Cancel Anytime”. However, the cancellation process involved:
- A paper letter with a handwritten signature asking to cancel
- Waiting six weeks to have the letter processed
- A subsequent form to be filled in and returned (by fax!)
- A deduction from your bank account for the processing fee
Even though the company made it sound like a simple process, they have created a series of inconveniences and barriers to discourage you from unsubscribing. This is sludge.
Ethical nudges
Critics often raise concerns about the ethical implications of using nudges to influence us to act against our initial preferences. In response, the authors of the book “Nudge” outlined specific constraints that nudges should adhere to —that is, they should be transparent, not covert or hidden. They should be in the interests of the people who are being nudged and consistent with their values. They should be subject to political safeguards, in the sense that if the people don’t like them, they should be able to say, “We don’t want that one.” And they should be consistent with constitutional understandings in the relevant nation.
“We’re very focused on ensuring that nudges are compatible with human dignity. If you’re nudged and you think, ‘That was awful. Why did that happen? I’m sadder and poorer,’ that’s an unethical nudge” said Cass Sunstein in an interview with McKinsey.
Types of nudges
Nudging can be broadly classified into two types, Transparent and Non-Transparent. There are several methods of influence in each of the categories, some of which are listed below.
Transparent
- Social proof: When in doubt, we tend to follow the crowd. Social proof is a form of influence that tells us how others behave in the same situation. This type of information or visual cue can help nudge an individual’s decision toward a specific selection. Customer reviews and star ratings are examples of social proof as they build a visible sense of crowd consensus. Encouraging members to rate their experience on review sites can help confirm to others that joining is a safe and positive choice.
- Rewards and punishments: Incentives and penalties can be used as a nudge to either encourage or discourage certain behaviours. For instance, a Netflix member may be incentivized to renew by offering an “early renewal” discount (reward) or disincentivized to let their membership lapse by instituting a late fee (punishment).
Non transparent
- Framing: The way in which a choice is presented can influence how we feel about it. Choices can be framed as either gains (e.g., “Become a member and receive great benefits!”) or losses (e.g., “Don’t miss out on your chance to see it first!”). FOMO is a type of framing as it can be used to negatively frame the opportunity of membership as a loss. An example of using FOMO in membership marketing is a call-to-action such as “Don’t miss out on the limited-time exhibition—join today and see it first!”
- Creating friction: Friction is usually described as being the opposite of easy. In most cases, choice architects seek ways to reduce friction to improve the user experience. However, friction isn’t always a bad thing to be avoided. In fact, intentionally slowing down the decision-making process or designing interventions that force people to pause and think about their decision can help them to make better choices.
- Priming: Priming happens when an individual is exposed to a subliminal stimulus (for e.g. images, words, etc) that affects how they respond in a subsequent situation. For example, exposure to seemingly unrelated words can prompt people to act in a certain way. In one study, students who were exposed to words like old and tired ended up walking slowly through a passage compared to those who were exposed to words like young and enthusiastic.
Conclusion
Since Harvard professor Cass Sunstein and University of Chicago professor Richard Thaler introduced the concept of nudging to the world, in 2008, about 400 “nudge units”—or behavioural-insights teams—have been established in public- and private-sector organisations around the world. By recognizing the above mentioned factors, behavioural economics provides valuable insights for policymakers, businesses, and individuals. The exploration of concepts like nudges demonstrates how small interventions can lead to significant behavioural changes, guiding more effective economic policies. As we delve deeper into these principles, behavioural economics will undoubtedly continue to shape our understanding of the world.
References
https://www.mckinsey.com/capabilities/strategy-and-corporate-finance/our-insights/much-anew-about-nudging
https://www.membershipinnovation.com/insights-and-ideas/an-overview-of-the-various-types-of-nudges
sludge
Richard thaler- intro to behavioural economics
Arthashastra 