What if people aren’t the rational decision-makers economics once assumed them to be? This article explores how behavioural economics challenges traditional theories by revealing the hidden biases, habits, and heuristics that shape our everyday choices—from supermarket aisles to energy bills—and how these insights are used by both businesses and governments to influence behaviour.
[Nathan is currently studying a Bachelor of Engineering and a Bachelor of Commerce at Monash University. As a writer for ESSA, he is fascinated by the quirks of human decision-making, and the insights behavioural economics offers into everyday life. With a strong interest in psychology, public policy, and market dynamics, Nathan enjoys exploring the ways in which economic theory interacts with the realities of human behaviour—both in the marketplace and beyond.]
Like all sciences, traditional economic theory rests on certain assumptions—that people act in their self-interest, that people act perfectly on perfect information, that people will always try to maximise their own wellbeing, that, in essence, people are rational. These are reasonable assumptions, to be sure; and they are certainly able to model the real world to some extent. But what if these assumptions are flawed? What if beneath outward appearances of rationality lie, however disconcertingly, discernible patterns of irrationality?
Here is a classic example. Flip a coin. Tails and you lose $100; heads and you win $150. Would you take the bet? Objectively the bet is favourable, because the expected value is +$25. But most people wouldn’t go for it; the possibility of losing $100 outweighs the possibility of gaining $150. This phenomenon, that “losses loom larger than gains”, is known as loss aversion. Of course, the economy is not made up of people deciding whether to partake in dubious bets; nevertheless, this simple example suggests that people’s decisions cannot always be predicted by models of perfectly rational minds. An obvious truth, perhaps, when it’s stated outright—but behavioural economics in its modern incarnation only dates back to the second half of the twentieth century. And there are many other examples of how our intuition, reasonable at a glance, can be plain wrong. For example, lots of people think that if a coin is flipped five times and five heads appear in a row, then the sixth flip is more likely to be tails.
So, humans are not wholly rational, after all; and it is the insights into the reasons behind this empirical observation that define the field of behavioural economics. Unsurprisingly, businesses consistently employ the observations of behavioural economics to sucker consumers into buying their products. To take the example of loss aversion: special deals are labelled “limited time only” to make consumers feel as if they’re losing an opportunity by not choosing to buy straight away. Products are never advertised as 1% fat, but 99% fat free, just as price tags will never display $5, but $4.99; the weapon here is called ‘framing’, the idea that how information is presented–’framed’–affects decision-making even if in both cases the information is the same.
Another sneaky scheme is a business automatically renewing consumer subscriptions. People tend to stick to defaults, – and hence some won’t bother to manually cancel their subscription if (when) they no longer use it—all the better for that business. This natural inertia to change highlights yet another potent weapon at the disposal of businesses: confusion. Complicated pricing plans, models, and deals push the limits of human willpower to make decisions when the considerations are plenty, conflicting, and overwhelming. In these cases, consumers may have the necessary information to make a decision in their best interests, and they would therefore do so under a traditional economic model; but, in truth, people just can’t (won’t) be bothered.
A study conducted in 2000 found that people exposed to 24 flavours of jam were much less likely to actually purchase a jar compared to those exposed to only six flavours; again, when choices are many, making a choice, any choice, is harder than making none at all, and therefore none is made.
Behavioural Economics for good
This is not to say that behavioural economics can be employed only by malign hands. Where the eccentricities of human behaviour can be exploited for good is in the setting of public policy. Organ donation is a nifty example. A 2003 study titled ‘Do Defaults Save Lives?’ found that when people were required to give explicit consent to be an organ donor, around only 42% of respondents opted in; but when the default option was already to give consent, 82% of respondents chose to become organ donors (by leaving the already selected option). Default bias at its best.
Another example: in energy markets, default bias often halts the spread of lower princes that is usually associated with increased competition. More competitors, there may be; but if people find comparing plans too much of a hassle, if there are even too many plans to consider, if energy bills are so confusing that researching the market for better options is too intimidating—then they will show what’s called ‘default bias’ and continue with their current plans, no matter how much they could be saving.
A 2018 study by the Behavioural Economics Team of the Australian Government (BETA) concluded that simpler energy bills—less jargon, more visuals—allow consumers to better understand their plan, reducing the associated inertia against searching for alternatives. And standardising layouts and terms increases comparability, again making it easier to look at different plans and therefore combatting default bias. A similar study conducted in 2021 showed that those who saw a ‘best offer’ from their retailer on the bill were 2-3 times more likely to switch. Notice how the number of options is minimal, effort required to find that best offer is slight, and the direct comparability between the offers given that they are from the same retailer—all intended to tackle default bias.
Conclusion
At the end of all this, it must be said that not all instances of irrational human behaviour require government intervention, or, in any case, not strong intervention anyway. For example, it has been noted that some people spend too much time watching television, even though they know it is in their best interests to do something else; and, surely, the government need not have any hand in that debacle. When governments do step in, however, the application of behavioural economics can nevertheless nudge people in the right direction by leveraging their innate decision-making processes. The result is that policies become not merely consequences of traditional economic theory, affecting abstract, incorporeal “economic agents”, but instruments that guide the decision-making of real, living, breathing people—hopefully for the better.
References
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Behavioural Economics Team of the Australian Government (BETA). (2018). Electricity information to fit the bill. https://behaviouraleconomics.pmc.gov.au/sites/default/files/projects/Fit-the-bill-report_0.pdf
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