Behavioural economics is the analysis of how human characters influence economic decisions. The study of behavioural economics mostly involves analysis of people’s social and emotional factors and their corresponding influence on economic decisions of individuals and corporations. Behavioural economics also looks at how peoples’ emotional, cognitive and social factors influence resource allocation, market prices and returns. In common terms, behavioural economics is the point at which economics meets psychology. Behavioural economists appreciate the fact that human beings are impatient and sometimes make biased conclusions. Furthermore, behavioural economists propagates models that respond to the fact that human beings are impatient, procrastinate and are not proper decision makers in challenging environments. The concept of behavioural economics appreciates the fact that people are sensitive to losses, they care about fairness and like economic gains (Camerer & Loewenstein 2004). General neoclassical (standard) economics study presupposes that individuals act logical and in a manner to maximise personal self-interest. This assertion entirely contravenes the concept of behavioural economics. This paper analyses behavioural economics in relation to other economic models as far as consumer choice is concerned.
An Overview of Standard Economic Model in Relation to Consumer Behaviour
Standard economic model, also popularly referred to as the neo-classical economic model, has been defended by many economists and policy makers. Proponents of this model of economics use it to analyse consumer welfare and consumer choice. This model of economics forms the basis for many economic consumption theories. Standard economic model is heavily based on the assumption that human beings are rational. Standard economics presupposes that people are fully aware of all the options available. The model further presupposes that people have the potential to rank their options in relation to preferences, consistently. Under this economic model, people always go for the options they admire most.
Standard economics model has several assumptions in regard to consumer behaviour. The first assumption is that human beings act with full information. This means that people do what they do because they have full information concerning their actions. This assumption means that people have full knowledge of all the options on the market and, therefore, whatever choice they go for is an informed choice. The model assumes that irrespective of the complexity of the situation human beings have the potential and can figure out the choices available and those that are not available. The second assumption of the standard economics model is that individuals have known preferences. This means that regardless of the set of choices available human beings will automatically know how to position the choices from the best to the worst. The third assumption is that individuals will always go for the best available (Camerer & Loewenstein 2004). This means that people will always prefer to go for the best ranked choice available. In a nutshell, standard economics model is founded on the hypothesis that people have full knowledge of the environment, both internal and external. The model also assumes that irrespective of the circumstances, people make rational choices.
Based on the above three assumptions, a consistent and logical theory of consumer behaviour can be advanced. Advocates of this model argue that the theory can be used to forecast consumer behaviour and those predictions can be compared with reality. Standard model economists reckon that this model correspond to real behaviour.
However, evidence from psychologists, economists and other researchers indicate clearly that the rationality assumptions advanced in the standard economics model are not correct. Evidence adduced by psychologists in this regard indicates that people are often irrational and that human beings are predictably irrational. Psychologists argue that if human beings were irrational in arbitrary ways, they would negate each other, therefore, leaving the ultimate conclusion in the hands of those with rational behaviour. In such circumstances, economic theories that ignore irrational conduct would be accurate. According to evidence from psychologists, human beings are irrational and predictable in similar ways and, therefore, the question of irrationality can not be ignored in consumer spending. Behavioural economists further argue that the fact that human beings are predictably irrational means that peoples’ predictably in irrational conduct can be easily incorporated into economic theories, which would improve their accuracy.
An Overview of the Tenets of Behavioural Economics
Evidence from behavioural economists indicates that, in many cases, human beings are unable to use their knowledge about available options and preferences to come up with best choices. Further evidence indicates that even if human beings know what is best for them, they are often tempted and succumb to unfavourable choices. As explained in the theory of behavioural economics, human beings are not irrational and are influenced by a number of issues as explained in this paper. One of the fundamental doctrines of behavioural economics is that individuals are influenced by the behaviours of other people. In other words, behavioural economists understand that the manner in which other people behave matters (Camerer & Loewenstein 2004).
Human beings act by observing others and aping. Human beings draw courage from other peoples’ approval. The other factor that is ably captured in behavioural economics is that people value habits. Human beings do numerous things without critically analysing their actions. People are not entirely in charge of their habits and, therefore, have no control of their choices. Behavioural economists believe that human beings are motivated to do things. In some instances, money de-motivates people because it undermines the individuals’ innate motivation. The other basic tenet of behavioural economics is that individual’s self-expectations have a bearing on people’s character. People also strive to align their actions to their commitments and values.
Contradictions and Similarities between the two Theories
Unlike other economic theories, behavioural economists believe that self expectation impacts on people’s economic choice in a number of ways. In any given society, people are governed by either social or cultural constructs. These determine how people value and commit themselves to some certain economic decisions. The other intriguing aspect in behavioural economics is that human beings are loss-averse and cling on to what they deem as theirs. In general terms, this principle means that people sometime make choices by default, and they cannot be swayed despite the circumstances. The six principles of behavioural economics are that people are incredibly poor at calculations when making choices. They are only obsessed with recent happens, and their decision are a reflection of the recent events. People are not good at working out probabilities, and they put great emphasis on things that are list likely to happen. Behavioural economists believe that people ought to be involved in effective change, as opposite to just giving them information and incentives.
Economics is a field that is characterised by computations and the unemotional parameters that popularly is refered to as homo economicus. Standard economic paradigm does not capture cognitive and psychological characters of people. Proponents of standard economic like neo classical economics reckon that standard economics is extremely accurate and has relevant models. Behavioural economics gained popularity because of the failures attributed to standard economics. Behavioural economics appreciates the concept of bounded self interests. Even though most economic theories assume the concept of self interested behaviour in their predictions, the aspect of bounded self interests heavily influences people’s economic choices. Proponents of standard economic model accept vast evidence from psychologists but sharply differ on the aspect of irrational behaviour (Schwartz 2007).
Supporters of standard economic model based their arguments on three aspects. The first aspect is the idea of competitive market trade. According to standard economic theory, market competition makes people behave rationally. For instance, a competitive market in the automobile insurance sector will mean that extremely high charges will apply to people who want to drive speedy but unsafe automobiles. Insurance companies will argue that the move to apply high rates is meant to discourage people from taking risks. However, it should be noted that liberal markets do not penalize all awful choices. According to (Schwartz 2007, p. 63), market competition does not make people irrational, although, financial markets are comparatively complicated. Behavioural economists caution that assumptions explained in the competitive markets analysis by using an analogy of complicated professionals who, a part from condemning foolish behaviour via unsophisticated individuals, encourage improper behaviour, because it is in their best interest do so.
Standard economic model presupposes that Darwinian evolution makes human beings rational. The Darwinian Theory states that individuals, who make poor choices, become unattractive. Such individuals will not attract mates and, therefore, will find it difficult to propagate. In other words, evolution ensures that individuals with rational behaviour propagate, while those with undesirable behaviour will extinct naturally. Behavioural economics counters this argument by stating that evolution a continuous process. Moreover, behavioural economists argue that behavioural characters that are disadvantaged through evolution in one way and may be a significant advantage in different contexts.
Another argument put forward by proponents of the standard model economics is that learning makes human beings rational. They state that, although, human beings are predictably irrational, they have the potential to learn from the mistakes of others. Therefore, this means that individuals can learn to be rational with time. Behavioural economists counter this argument by claiming that individuals, who make stupid decisions, may again be too stupid to learn from the experiences of others or may altogether fail to invest in education. Behavioural economists again reckon that some crucial decisions may only happen once in a lifetime. This means that there are no chances for second guessing in some decisions (Schwartz 2007). In summary, model of behavioural economic presupposes that there are few opportunities in life for people to make critical decisions. Consequently, there are limited opportunities for people to learn from past mistakes. The theory cautions that if there are high possibilities for poor choices and just a sing possibility for a good choice. It might take seriously expensive experiments to arrive at the best choice. For instance, it is increasingly becoming clear that the global economic trend is headed the wrong direction. The world economy is contracting constantly. Inflation is on the increase, and the interest rates are sky rocketing.
This means that economic conditions are uncertain. The economy is at the state, where no one knows exactly what will happen in the next minute. With the current financial system, people are likely to experience an escalation of debts, occasioned by high interest rates; this is likely to erode much, if not all of the remaining capital. Unfortunately, people in governments appear to be having no solution, even though, there are many options available. America spent enormous sums of money and lost billions of dollars in an attempt to rectify the worsening economic conditions. Banks operate in a liberalized environment, and the government had no authority over them. The recent activities in the American banking industry cannot just be regulated on its own. The United States government tried to set limits for financial institutions, with little success.
Under the current form of liberalized supply and demand, it is not easy for governments to interfere with banking even if it is for the common good. Again, governments are reluctant to interfere because their finances have deteriorated immensely since the initial banking crisis. The global nature of current banking makes even the strongest banking institutions become vulnerable to bad debt contagion. This is because of the inter-banking policy that allows banks to own stake in other banks. The crumple of Spanish, Irish or Portuguese banks will have a negative effect on British, German, or French banks, and consequently all their counterparts somewhere else.
The current style of banking comprises of multiple interconnected risks, respecting no boundary. In as much as the governments have the power to rescue banks from whatever problems, the public is becoming increasingly intolerant, and it is going to be extremely difficult for governments to finagle a second banking rescue from public offers. According to Schwartz (2007, p. 68), the ruling class has continued to encouraged people to believe that banking institutions are sound because they are not sure of which rational decision to make. Instead, they have predictably made every person trust banks blindly, and bankers at present are wicked and not worthy of public support. This explains why the single alternative that central banks have, is to keep on flooding the financial system with fresh cash, to reimburse for the deflationary effects of constricting bank credit. Such fresh cash in the central banker’s intellect can be directed to sustaining the weaker associates of the banking system, as proponents of standard economic model would put it, provided fundamental economic stimulus. Nevertheless, it seems like consecutive pouring in of new money has no significant impact on the ground. This strategy cannot address potential economic problems facing the banking sector (Fisher 2009).
The above scenario demonstrates how difficult and expensive it is to make a rational decision out of many irrational choices. Moreover, the above example discredits standard economic model in many aspects. One wonders how often human beings choose the best option available. There are many satisfactory answers to this question ranging from more often and without exceptions to usual, but with unusual exceptions. The concept of behavioural economics approaches matters concerning people’s economic choice from a psychological point of view. This form of prediction is accurate because it makes economic forecasts based on the evidence of people’s predictable irrational conduct.
Although, the aspects of market competition, learning and Darwinian evolution may have a negative bearing on people’s irrationality overtime, these procedures might not work properly and may consume time. Standard economic theory, on the other hand, presupposes that human beings are strong willed, rational and self-interested. Evidence from psychologists sharply contrasts these views. Psychologists confirm that human beings are irrational and predictable in nature. Moreover, psychologists argue that human beings are prone to making poor choices even in situations where the possibility of making rational decisions is high. Based on the analysis of both standard and behavioural economics models, it is worth noting that behavioural economics is superior in terms of accuracy. It captures all the aspects that make people human. In contrast to standard economics model, behavioural economic approaches the question of consumer choice in relation to a psychological point of view and confirms that human beings are irrational and predictable.