How to Make Sense of Behavioural Economics

Published Categorised as Organisational Psychology
A high-level theory for understanding and applying Behavioural Economics

When I first began researching the field of Behavioural Economics, it was quickly made apparent that my task would be a challenging one. You are immediately overwhelmed by long lists of applicable concepts and frameworks, each attempting to categorise a never-ending number of heuristics and biases. This is only made more complex by ambiguous language, and a confusing mix of terminology. There is no doubt of the enormous potential of this field, however knowing where to start and how to make sense of the huge amount information, can be a difficult and daunting process.

In this blog I provide a method to help you understand and apply behavioural economics interventions with confidence.

Problem Number 1: Long Lists

The task of understanding human psychology, and more specifically it’s effects on the choices we make, is made more difficult in light of the vast number of biases and heuristics the human mind can fall prey to. From anchoring, to loss aversion, to status quo bias, to the zero price affect; the ever growing lists can quickly scare away the most avid of researchers.

By far, the best attempt to categorise them all is the Cognitive Bias Codex.

Note: Whilst the number of biases and heuristics with relevance to Behavioural Economics is smaller, the lists remain large and overwhelming none-the-less. Click here for the full sized image.

These lists can prove useful when seeking out information on a specific intervention, but by failing to acknowledge the bigger system these biases are a part of, these lists overwhelm the reader by the sheer number of potential interventions.

To best apply these concepts in the real world, a framework is needed. One in which the broad range of behavioural economic concepts are viewed as a small part of a larger picture.

Problem Number 2: Confusing Terminology

Another difficulty faced when first delving into the world of Behavioural Economics is that the lines between specific terminologies are blurred. Concepts such as Behavioural Economics, Behavioural Design, Behavioural Science, Behavioural Interventions and Change Architecture are frequently used interchangeably to the confusion of many and the detriment of the field.

We need a unifying language through which we can approach this innovative field. Anchoring nebulous concepts to shared definitions acts as a common denominator to discuss and apply theory.

The following framework aims to solve these two problems by separating out some of the definitions in the field as well as contextualise them into a framework which makes it easier to think about and apply this amazing science.

The Birthplace of Behavioural Economics

Behavioural Science: The study of observable and quantifiable aspects of behaviour (excluding subjective phenomena).

Economics: The branch of knowledge concerned with the production, consumption, and transfer of wealth. Many economic theories are based on an imaginary figure referred to as, “The economic (or rational) man”. The economic man portrays humans as consistently rational and narrowly self-interested agents who usually pursue their subjectively-defined ends optimally. Is basic terms, many economics theories account for the decision making process as rational, when in fact this is not always the case.

Behavioural Economics: These theories were turned on their head with the introduction of Behavioural Economics which applied psychology to rational economics theory to prove that people aren’t the logical robots economists previously thought them to be.

For example, Amos Tversky and Daniel Kahneman’s Prospect Theory (also known as Loss Aversion Theory), demonstrated that a person’s willingness to take risks are not always rational but can be shaped by changing the way in which a choice is framed.

Have a look at the following classic decision problem:

Which of the following would you prefer:

  1. A) A certain win of $250, versus
    B) A 25% chance to win $1000 and a 75% chance to win nothing?
  2. How about:
    C) A certain loss of $750, versus
    D) A 75% chance to lose $1000 and a 25% chance to lose nothing?

Tversky and Kahneman’s research revealed that a greater proportion of people select options A and D in keeping with the theory of Loss Aversion which demonstrates that in order to avoid a loss people are willing to take a risk they wouldn’t otherwise have taken on an equal gain.

This is only one example of the many mental shortcuts taken in the decision making process. Before we can take advantage of these processes we must first understand the psychology behind these decisions.

Thinking Fast and Slow

The best selling book by Daniel Kahneman “Thinking Fast and Slow”, brings to the fore the key theoretical basis for behavioural economics. The authors central thesis being the dichotomy between two modes of human thought:

System 1 “Thinking Fast” is automatic, unconscious, fast, instinctive, emotional and reactive.

This system is engaged when an experienced driver, drives to work in the morning. The complex act of shifting gears and switching lanes is as natural as walking.

System 2 “Thinking Slow” is controlled, conscious, slower, deliberate, and logical.

This system is engaged when your first learn to drive your car, it requires conscious effort to understand and acquire the new skill.

People spend most of their time in System 1. It is automatic and requires less processing power to operate. However to achieve such efficiency Thinking Fast relies on ‘rules of thumb’, heuristics, which are susceptible to biases and therefore less than optimal for decision making.

Thinking Fast doesn’t always serve us.

This is evident every time a well-intentioned person fails to follow through on their desired behaviours. For example new years day sees millions of people resolving to live a fitter and healthier life. However the automatic brain didn’t get the message, and once the stresses of life set in, good intentions are forgotten and usual behaviours kick in once again.

Behavioural Economics helped to explain how and why we behave like we do, however to apply this theory to solve real world problems a different approach is needed.

Enter Behavioural Design

Behavioural Design: is a sub-category of design and behavioural economics concerned with how design can shape, or be used to influence human behaviour. It is the systematic and practical application of behavioural economics theory, specifically to do one; or a combination of, two things.

This framework sees Behavioural Economics as a new theory which takes into account the importance of how people actually behave when presented with a choice (often fast thinking and based on heuristics).

Behavioural Design provides a way to apply this theory; shaping our choices by subtly nudging people to make better decisions or directing them out of the automatic ways of thinking to make conscious, thought-through choices.

Bringing it all together

Model of Behavioural Economics

This model provides a base from which individuals can begin their dive into the world of Behavioural Economics. Most importantly, next time you feel swamped with lists and choices when it comes to behavioural interventions remember to ask yourself;

How could this intervention subtly nudge our automatic brain into making the preferred decision?

How could this intervention direct people to engage with their analytical brain to override their automatic thinking and thus make more calculated decisions?

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