Chapter 4 - 3

03 Economics

Behavioral Economics

Behavioral economics is a field that attempts to understand how consumers make choices that affect the marketplace.

It began in the classical period (1776-1870).

At this time, the field of economics was closely tied to the field of psychology.

During this era, economists were deeply interested in what drove particular consumers to make particular decisions.

These choices, behavioral economists believed, were closely tied to how much utility a person derived from making them.

Behavioral economics rests upon a few key assumptions.

First, it dictates that individuals will be rational in their decision-making process.

This does not necessarily mean that they will make a choice that is economically beneficial to them.

Instead, behavioral economics asserts that people will make a decision that will result in some perceived increase in utility.

For instance, many people often give to charity.

In purely material terms, they are not making a sound economic choice.

There is little physical benefit they receive in exchange.

However, by giving to charity, consumers may feel more satisfied with themselves.

In turn, they experience an overall increase in utility.

Second, behavioral economists recognize that people make choices based upon how certain situations or products are framed.

In economic terms, framing refers to the way products are phrased or explained to consumers.

For example, the painkiller aspirin was once used only for headache relief.

As time went on, pharmaceutical companies realized that aspirin could be used for other painful ailments.

Through successful framing of aspirin’s additional benefits, companies were able to increase their customers’ utility.

As a result, aspirin sales rose significantly.

Thus, framing can have a major influence over buying behavior when it appeals to consumers’ concepts of utility.

Finally, behavioral economists are forced to recognize non-rational decisions by consumers.

Non-rational decisions result from a miscalculation in a particular situation.

Most misperceptions are attributed to social psychology.

This is where a crowd misinterprets particular elements of an object or situation.

For example, many feel that an increase in wealth always leads to an increase in utility.

However, studies have proven that while increasing wealth can increase utility up to a certain level, eventually people reach a point when wealth no longer matters as much.

In this case, the utility from making more money quickly diminishes.

Despite this proven fact, many people continue to believe that more money will bring increased happiness.

These beliefs affect the choices they make in their daily lives.

Both rational and non-rational factors may influence an individual’s decisions.

Thus, behavioral economics is a complicated and sometimes unpredictable field.

It is nearly impossible to evaluate every variable that determines a single individual’s choice.

However, behavioral economists focus on much larger groups.

By spotting trends in larger groups of people, behavioral economists can help businesses.

With an understanding of particular patterns in consumer behavior, businesses can adjust their advertising, pricing, or production models to maximize sales.

At one time, behavioral economics was disregarded by most economists.

They thought it too abstract and dynamic to be worthwhile.

The field has become more popular in the last several years, however, and continues to grow.