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With the world constantly evolving, many new issues in policy-making, environmental issues, and consumer behaviors are revealed. Sensible decisions are required to align with the ever-changing society. In traditional financial theories, researchers assume that individuals are homo economicus, which means people with rational minds. However, recent studies found out that this is not a realistic assumption and it is difficult to make the best decision even when people consider their minds clear, especially under uncertain circumstances.
According to Cartwright (2014, p.1), “Behavioral economics is about understanding economic behavior and its consequences. For instance, the reasons for purchasing a certain product or saving money. It also examines whether people make good or bad choices, and could be helped to make better choices.” In the essay, the aim is to prove that behavioral economics is essential to help analyze human behavior and give suggestions and solutions whenever needed to make better decisions. Therefore, if theories regarding human behaviors can be introduced to persuade individuals that this is an existing problem and a set of system could be applied to guide the human brain to make rational judgments, it might be useful to establish better policies in the government and guide consumers to make decisions beneficial to them.
First, in the essay, reasons and scientific evidence observed by behavioral economists will be shown why people are not as rational as they thought because by proving that, the importance of applying behavioral economics can be demonstrated. In addition, proving the weakness in the standard economic model. Next, examples in some of the fields that already have made behavioral economics theories practical will be illustrated as evidence that this is helpful to enhance the effect of a policy or a decision made by people.
The irrationality within human nature is the reason why behavioral economics is vital to lead policymakers or individuals to make more sensible decisions. Behavioral economics provides a deeper view of this aspect to demonstrate in which scenario people might make biased movement and what is applicable at that moment. Several elements will be revealed to prove the assumption in traditional theories questionable.
First, it is about whether people can make good decisions that influence their future. Cartwright (2014) discussed the projection bias, which raises questions about adaption issues. Upon making decisions for the future, they would mainly take their current taste and preferences into consideration, but they might not think thoroughly about the uncertainty lies in the future. One could exaggerate the fact that future events will be similar to their past experiences. Therefore, it could be seen again that individuals are not quite rational when making decisions.
Another aspect is whether people have enough self-discipline to keep up with the commitment they made to themselves. Researchers examine the function of a commitment device to people. A commitment device is a decision made by people when they are thinking rationally. They utilize this device to try to remind them not to do something regrettable. In this case, Cartwright (2014) states that this might not be a permanent measure to solve problems. Since people might underestimate the present self, the probable outcome could be that the commitment device was ignored because they choose to stick to the present self. This case is also illustrated by Goldstein (2011) who clarified that the present self is the only one making decisions while the future self is merely a projection that is likely to remain the same. Furthermore, he argued that it is hard to resist temptation, and people lack the self-discipline to realize their goals.
Through the findings in behavioral economics, it has been made clear how people tend to react and make decisions with biases that result in unsuitable decisions. Therefore, emphasizing the need to apply behavioral economics and if people could acquire the concepts mentioned, they could apply behavioral economics in their daily lives to become more realistic and make effective decisions. The application of behavioral economics in the fields of policy-making, consumer behavior, and human health has been seen recently and there are some actual measures indicated that could help people make better decisions in different aspects.
Making use of behavioral economics in reality can help solving many existing problems in policy-making, consumer behavior, and health issues. There will be methods and examples demonstrated in the following paragraphs to support this statement. The first measure is about applying scientific methods. Goldstein (2011) invented a virtual simulator called distribution builder. In the simulator, by dialing in the income of a person’s retiring salary it would show what kind of house one can afford with the amount of money they possess. Another invention from Goldstein (2011) is the behavioral time machine. It compares the younger self and the older self of a person to see how present decisions influence the future. The image of both sides is linked together by the percentage of saving (smoking, exposure to the sun, etc.) at present. By applying these two measures, they could solve the projection bias because of the consequences demonstrated immediately as an alarm.
Nudge Theory is also a useful kind of method, which can assist individuals to make better choices without too much interference. According to Thaler & Sunstein (2008, p.6), “A nudge is any aspect of the choice architecture that alters people’s behavior in a predictable way without forbidding any options or significantly changing their economic incentives. To count as a mere nudge, the intervention must be easy and cheap to avoid. ” Thaler & Sunstein (2008) made this concept popular in their book called Improving decisions about health, wealth, and happiness. Moreover, Angner (2016) illustrates how nudges help rational and informed people make better decisions instead of making decisions for them. Furthermore, it can be helpful to decision-makers who are not as rational. It can also help solving the persuasion issue in many cases and help one’s mental model match with reality. An example mentioned by Mullainathan (2009) looked into a company called Positive Energy that try to solve the energy efficiency problems. It captures the concept of a nudge and applies it simply by sending letters to households telling whether they use more energy than their neighbors. This measure turns out to be a huge success because it reduces two to three percent of energy use, which represents saving 900 million dollars per year. The letter provides information about other households, which has the function of social norms and that changes an individual’s energy consumption behavior in an implicit way. He mentioned that the problem within the decision-making is often not because of the insufficient data or technologies given, but human innovation. The application of nudge in this case solved the persuasion issue that normally cannot be solved by the government when utilizing merely propaganda.
For policy-making, it is important to know how people’s mind works to create a policy that citizens are willing to abide by no matter the occasion. This is when behavioral economics could be useful. According to a famous example mentioned by Thaler & Sunstein (2008), the Schiphol International Airport print an image of a fly onto the urinals in the airport to reduce spillage in the toilet and surprisingly, it decreased by 80 percent. Another case that government benefits from the utilization of behavioral economics is illustrated in the UK. Beggs (2016) referred to the success of the team created by David Cameron in 2010. Since the government also has the issue of generating revenue, which is the amount of tax it received. This team aimed to find ways to make sure citizens comply with the policy by using nudges. In this case, the team sent a personalized letter to people who owed taxes on their car, which informs them that their neighbors have already paid the taxes to the government. The outcome of this measure increased the tax payment rate by 15% and 28% for those who owed fines to the court. The nudge used in policy-making not only helps the government with tax revenue but in the long run, because people pay their taxes on time, they avoid problems such as fines or interest.
Behavioral economics could mend irrational consumer behaviors by reminding individuals to think thoroughly about the decision before taking any action. The case in a company Betterment can provide a positive example. Egan (2015) found out in his interview with the company that it discovered a behavior that investors often turn anxious upon finding the situation in the market going down. When this scenario happens, they tend to opt out and sell their shares at the lowest value, which is a terrible thing to do. Therefore, it provides a service called “tooltip”, which sends alert to the customer when they are trying to withdraw money and the figures illustrated that this service reduced the withdrawals rate by 10%.
Besides, the application of behavioral economics can guide individuals to live a healthier lifestyle. Wendel (2016) mentioned a company called Jawbone applied behavioral economics into their service to help the users to get a good night’s sleep. The team at Jawbone utilized a principle in behavioral economics named “commitment and consistency” in their mobile application. A commitment and consistency according to Cialdini (2007) is a leaning in the human mind that once made a commitment, people tend to follow through the commitment they created. In the application, there is a sleep tracker that will pop up messages to remind the users it is time to go to bed and it is better to rest earlier. After Kwong (2015) measured what influences the simple nudge can do, statistics showed that it made the users 72% more likely to rest up earlier to have a seven-hour sleep.
Despite the positive examples mentioned above, it should be noted that there are also some drawbacks when applying nudges or there might be negative nudges a choice architect utilized not solely for individuals’ benefit. Beggs (2016) indicated a drawback spotted in the previous example of energy preservation. When people who originally consume less energy than the average read the information in the letter, statistics showed that some of them increased their energy consumption afterward. An example when private companies used nudge for their benefits is also shown by Beggs (2016). When shopping online, companies often offer free shipping once consumers’ merchandise reachs a certain amount. However, individuals might be attracted by the free shipping notion and at last buy unnecessary products only to reach the threshold of free shipping.
In this essay, reasons are mentioned about why do people need behavioral economics and it was mainly because of the human nature that needs to be clarified and discover ways to cope with it. The content above brought the readers closer to the vague term behavioral economics by providing the observation from behavioral economists about people’s mental processes when making decisions. In addition, discussing cases in reality and methods they utilized to make positive changes.
The application of nudge and commitment and consistency devices could mend individuals’ behaviors to make decisions that could impact people’s health, energy preservation issue, and increase the convenience of both citizens and the government. In the government case, the measure minimized the unpleasant feelings citizens might experience when they need to pay taxes; furthermore, they can avoid fines because of procrastination. Meanwhile, the government generates revenue to invest in society. The commitment and consistency device that was adopted by the company aligns people’s knowledge with their actual deeds. By constantly reminding users about the time they should go to bed solves the problem that people cannot keep up with the commitment they made to themselves previously. However, some disadvantages might arise from applying knowledge of behavioral economics. Therefore, it is important for individuals to possess critical thinking about offers or information they received so that people can preserve their autonomy in all kinds of scenarios. Several other facets of behavioral economics are still debatable but due to the length of the essay and the author’s knowledge cannot be included.
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5. Edward Cartwright, 2014. Behavioral Economics. [e-book] Routledge. Available through: University of Warwick Library website
6. Goldstein, 2011. The battle between your present and future self. [online] Available at:<https://www.ted.com/talks/daniel_goldstein_the_battle_between_your_present_and_future_self/up-next> [Accessed 18 August 2019]
7. Jodi N. Beggs, 2016. Private-Sector Nudging: The Good, the Bad, and the Uncertain. In: Abdukadirov S. ed. 2016. Nudge Theory in Action. Palgrave Advances in Behavioral Economics. Palgrave Macmillan, Cham. pp. 125-158
8. Mullainathan, 2009. Solving social problems with a nudge. [online] Available at: https://www.ted.com/talks/sendhil_mullainathan/up-next
9. Kwong, Kelvin. 2015. A smart coach by your side. The Jawbone Blog, January 28. https://jawbone.com/blog/smart-coach-side/. Accessed 1Sep. 2019
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11. Steve Wendel, 2016. Behavioral Nudges and Consumer Technology. In: Abdukadirov S. ed. 2016. Nudge Theory in Action. Palgrave Advances in Behavioral Economics. Palgrave Macmillan, Cham. pp. 95-124
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