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Behavioural Economics - Psychology and Economics

VSAT 2022

Behavioural Economics: An Introduction

Behavioural Economics is a field which involves the study of Psychology and deals with the economic decision-making processes of an entity, an individual or an institution.


Introduction to Behavioural Economics


Introduction to Behavioural Economics

What is Behavioural Economics?

Behavioural Economics explains the irrational economic decisions taken by individuals sometimes. It helps understand why a person chooses Choice A instead of Choice B. In the present era, when there is a variety of choices available for people, the Rational Choice theory of economics comes into play. This theory states that when humans have various options under conditions of scarcity, they choose the option which gives them maximum satisfaction. According to the theory, after rationally doing a cost and benefit analysis of every option available to them under the circumstances, choose the best option.


Behavioural Economics


Behavioural Economics


Behavioural Economics also seeks to explain how irrational economic decisions tend to affect an individual. Behavioural Economics explains the reasons behind irrational decisions made by an individual. As humans have emotions, distractions and varying self-control, they sometimes choose an option which is not rational and thus gets affected afterwards.

 Six essential Behavioural Economics principles are:

  • The Overconfidence Effect

  • Temporal Discounting

  • Loss Aversion

  • Anchoring and Framing

  • Social Norms

  • The Peak-End Rule

Behavioural Approach

Behavioural Approach is concerned with the behaviour of human beings rather than the mind. It involves a behavioural decision making process. This approach advocates that human behaviour is a learned aspect; therefore, all behaviours can be unlearned, and new behaviour learned in their place. The Behavioral approach is the most effective way of treating Behavioural Disorders and other Impulse Control disorders. This can also be used to treat anxiety and other mental disorders. BF Skinner is the founder of the Behavioural Approach.


The behavioural approach takes into consideration that human beings are not incapable of making errors and that through rational decision-making and proper behaviour control, errors can be amended.

Behavioural Finance

Behavioural Finance deals with studying the psychology of investors and financial markets. Behavioural Finance explains why investors make decisions that are not in their best interest. It focuses on rational decision-making. 


Behavioral Finance


Behavioural Finance


Summary

Behaviour Economics has its foundation in the Behavioural Approach, which believes that the behaviour of human beings is dynamic and thus can be learned and unlearned. It requires efforts to change behavioural patterns. This behavioural approach is utilised in almost every discipline since it provides a sense of positive affirmation. Some of the behavioural economics examples are very common. In Healthcare, patients tend to believe that they will be cured after treatment. In education, students tend to perform better when provided a small treat. Behavioural Economics, in the same way, focuses on making the best choices and keeping the situations in mind.

FAQs on Behavioural Economics - Psychology and Economics

1. Give an example of a behavioural approach.

Positive Reinforcement is the most common example of behaviourism. Students study for three hours continuously in the hope of getting a reward from their parents after studying seriously. The bigger the reward, the harder the students study. The behavioural approach is useful in treating various diseases. Many mental disorders can be treated with the help of this approach. It is particularly more helpful in treating anxiety. Since our behaviour is in our control, we can change our habits and thus our lifestyle by making small and gradual positive behavioral changes.

2. What is the significance of behavioural economics?

Behavioural Economics helps investors in making informed and rational economic decisions, and it also explains the reasons why one should choose option A instead of option B. Behavioural Economics plays an important role in our daily life as we need to make economic decisions at every step in our routine life ranging from purchasing vegetables to purchasing jewellery. These economic decisions are made rationally while keeping other decisions also in mind. Thus, Behavioural Economics is an important branch of macroeconomics and finds application in almost every aspect of life.

3. What are the applications of behavioural economics?

The applications of Behavioural Economics are:

  • Behavioural Economics is used by governments while making policies to get proper insights into economic decisions.¬†

  • Businesses use behavioural economics in their business strategies.

  • It finds application in Behavioural Finance, which needs critical decision-making power in the capital market.

  • Behavioural Economics also finds application in a middle-class household since every decision regarding a big or small purchase is made keeping in mind the economic condition of the house.

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