ECONOMICS PROJECT

Behavioural Economics In Everyday Life

Behavioural economics combines elements of economics and psychology to

understand how and why people behave the way they do in the real world. It
differs from neoclassical economics, which assumes that most people have
well-defined preferences and make well-informed, self-interested decisions
based on those preferences.

It is often related with normative economics. It draws on psychology and

economics to explore why people sometimes make irrational decisions, and
why and how behaviour diverges from the predictions of economic models.

Understanding Behavioural Economics

In an ideal world, people would always make optimal decisions that provide
them with the greatest benefit and satisfaction. In economics, rational choice
theory states that when humans are presented with various options under the
conditions of scarcity, they would choose the option that maximizes their
individual satisfaction.

This theory assumes that people, given their preferences and constraints, are
capable of making rational decisions by effectively weighing the costs and
benefits of each option available to them. The final decision made will be the
best choice for the individual. The rational person has self-control and is
unmoved by emotions and external factors and, hence, knows what is best for
himself. Hence, behavioural economics explains that humans are not
rational and are incapable of making good decisions.

Because humans are emotional and easily distracted beings, they make
decisions that are not in their self-interest. For example, according to the
rational choice theory, if Charles wants to lose weight and is equipped with
information about the number of calories available in each edible product, he
will opt only for food products with minimal calories but that is not what he may
do.

The field of study known as behavioural economics initially began as a purely

academic attempt at modelling irrational consumer choices, thereby challenging
the notion of the rational consumer of traditional economics. However, recent
events have launched behavioural economics from a purely academic pursuit to
the forefront of public policy and pop psychology.

Theoretical Framework

 Bounded Rationality:

Bounded rationality is a concept proposed by Herbert Simon that challenges the

notion of human rationality, Rationality is bounded because there are limits to
our thinking capacity, available information, and time (Simon, 1982). Bounded
rationality a core assumption of the “natural assessments” view
of heuristics and dual-system models of thinking and it is one of the
psychological foundations of behavioural economics.
Some examples may help clarify these ideas. When the precept being violated is
to “buy footwear that fits one’s feet” (an admonition that will no doubt find wide
acceptance), the consumer’s action might be to purchase a pair of shoes that is
instead one-half size too large. This behaviour would be considered boundedly
rational if the shoes being purchased were needed for a wedding this afternoon
and if a perfectly fitting pair could be obtained for certain only by visiting each of
10 geographically dispersed shoe shops. In this instance, thinking of the decision
maker simply as an optimizer of comfort would lead to puzzlement at his
selection, but the purchase of poorly fitting shoes looks reasonable enough
when the consumer’s limited knowledge of the retail environment is considered.
The American social scientist Herbert A. Simon, an influential proponent of the
concept of bounded rationality, used the terms “substantive” and “procedural” to
distinguish between the notions of rational behaviour commonly adopted in,
respectively, economics and psychology. According to this usage, an agent is
substantively rational if he has a clear criterion for success and is never satisfied
with anything less than the best achievable outcome with respect to this
criterion. For an agent to be procedurally rational, on the other hand, it is
necessary only that his decisions result from an appropriate process of
deliberation, the duration and intensity of which are free to vary according to the
perceived importance of the choice problem that presents itself. The concepts of
“procedural” and “bounded” rationality are thus roughly the same, and both are
closely related to the idea of “satisficing,” also promoted by Simon.

 Heuristic and Biases:

Many decisions are based on beliefs concerning the likelihood of
uncertain events such as the outcome of an election, the guilt of a
defendant, or the future value of the dollar. These beliefs are usually
expressed in statements such as "I think that . . . ," "chances are . . . ," "it is
unlikely that . . . ," and so forth. Occasionally, beliefs concerning uncertain
events are expressed in numerical form as odds or subjective
probabilities. What determines such beliefs? How do people assess the
probability of an uncertain event or the value of an uncertain quantity? As
a result, people use a number of mental shortcuts, or heuristics, to help
make decisions, which provide general rules of thumb for decision
making (Tversky & Kahneman, 1982). However, the same glossing over of
factors that makes heuristics a convenient and quick solution for many
smaller issues means that they actually hinder the making of decisions
about more complicated issues (Tversky & Kahneman, 1982).

A cognitive bias (e.g. Ariely, 2008) is a systematic (non-random) error in thinking,

in the sense that a judgment deviates from what would be considered desirable
from the perspective of accepted norms or correct in terms of formal logic. The
application of heuristics is often associated with cognitive biases. Some biases,
such as those arising from availability or representativeness, are ‘cold’ in the
sense that they do not reflect a person’s motivation and are instead the result of
errors in information processing. Other cognitive biases, especially those that
have a self-serving function (e.g. overconfidence), are more motivated. Finally,
there are also biases that can be motivated or unmotivated, such
as confirmation bias (Nickerson, 1998).

As the study of heuristics and biases is a core element of behavioural economics,

the psychologist Gerd Geiringer has cautioned against the trap of a “bias bias” –
the tendency to see biases even when there are none

 Prospect Theory

Prospect theory is part of the behavioural economic subgroup. It

describes how individuals make decisions between alternatives where
risk is involved and the probability of different outcomes is unknown.
There is a certainty effect exhibited in the prospect theory, where people
seek certain outcomes, underweighting only probable outcomes.
Prospect theory was first introduced in 1979 by Amos Tversky and Daniel
Kahneman, who later developed the idea in 1992. The pair said that the
prospect theory was better at accurately describing how decisions are
made, compared to the expected utility theory. Kahneman and Tversky
proposed that losses have a greater emotional impact than a gain of the
same amount. They said that, given choices presented two ways—with
both offering the same result—an individual will pick the option offering
perceived gains. Prospect theory says that individuals will accept an
investment when the gains are presented, versus the losses. That is,
investors weigh potential gains more than potential losses.

 Behavioural Economics in Daily Decision-Making:

Behavioural economics explores the psychological factors that influence
human decision-making, providing valuable insights into purchasing
decisions, brand loyalty, and consumer habits. Traditional economic
theories often assume that consumers are rational actors who make
decisions solely based on maximizing utility. However, behavioural
economics recognizes that cognitive biases and heuristics often lead
individuals to deviate from purely rational behaviour.

One key aspect of behavioural economics is the understanding of how

cognitive biases, such as loss aversion and the endowment effect,
influence purchasing decisions. Loss aversion, the tendency to prefer
avoiding losses over acquiring equivalent gains, can make consumers
more sensitive to price increases than to price decreases. The endowment
effect, where people ascribe higher value to objects they own, can lead to
 brand loyalty as consumers are reluctant to switch to new brands even
when better alternatives exist.

Heuristics, or mental shortcuts, also play a significant role in consumer

behaviour. For instance, the availability heuristic can cause consumers to
overestimate the likelihood of events based on how easily they recall them, such
as assuming a product is high-quality because it's frequently advertised.
Anchoring, another heuristic, influences decision-making by setting a reference
point (such as an initial price) that consumers use to judge the value of a product
or service.

Taking an example of Shopping choices: Decoy Effect: When presented with

three options, people often choose the middle option. For instance, if a coffee
shop offers small, medium, and large coffees, with the medium priced close to
the large, customers are more likely to choose the large, perceiving it as a better
deal. Another example of Time Management: Hyperbolic Discounting: People
often choose smaller, immediate rewards over larger, later rewards. For
example, a student might choose to watch a movie instead of studying for a test
because the immediate pleasure outweighs the future benefit of doing well on
the exam

Applications in Marketing and Advertising:

Understanding consumer buying behaviour is vital for marketers, as it sheds

light on why consumers make the decisions they do. In turn, this will help
marketers to understand which of their campaigns are more effective, and to
more highly target their marketing spend in the future, increasing return on
investment.

There are three types of human needs: basic needs (such as food, water,
warmth and security), psychological needs (such as loving relationships) and
self-fulfilment needs (reaching one’s full potential). When one of these needs
isn’t being met, the consumer might decide that making a purchase will rectify
this.

For example, maybe their running shoes have worn out, meaning they can’t
exercise and so can’t meet their self-fulfilment needs of staying healthy, hence
the search for a new pair.

Different Types of Consumer Behaviour

There are four main types of consumer behaviour:

1. Complex buying behaviour
This refers to buying infrequent, expensive products, like a house or a car.
Because of the expense and emotional investment involved, consumers are
highly involved in the purchasing process, and do extensive research.

Consider someone looking to purchase their first home. Buying a house is a

significant, infrequent expense that involves immense emotional and financial
investment. Such consumers typically engage in extensive research, exploring
various neighbourhoods, considering property types, analysing financing
options, and assessing their long-term needs.

The decision-making process is prolonged and intricate, involving consultations

with real estate agents, financial advisors, and often seeking advice from family
or friends. The level of involvement and thorough research are characteristic of
complex buying behaviour due to the high stakes and substantial commitment
involved in the purchase.

2. Dissonance-reducing buying behaviour

The consumer is still highly involved, but has difficulty choosing between brands
and worries they may regret their choice.

Imagine someone shopping for a new laptop. They are highly involved in the
process, researching various brands, specifications, and features extensively.
However, despite their thorough investigation, they are still uncertain about
which brand or model to choose. They fear they might regret their decision or
miss out on a better deal. This uncertainty leads to a feeling of cognitive
dissonance—a conflict between the desire for a good purchase and the worry of
making the wrong choice.

In an attempt to reduce this dissonance, they may seek reassurance through

reviews, comparison websites, or by consulting with tech-savvy friends to gain
more confidence in their decision. Ultimately, their high involvement coupled
with lingering doubts characterizes dissonance-reducing buying behaviour.

3. Habitual buying behaviour

With these purchases, the customer has little involvement in the product or
brand category. These patterns are established over the long term, and typically
involve low-cost items – for example, the type and brand of bread, soda and milk
you buy.

Think of someone who regularly purchases a specific brand of soda. They have
established a routine where they automatically reach for this particular brand
without much thought or consideration. This behaviour is ingrained over time;
they hardly deliberate or actively compare alternatives when buying soda. It is a
low-involvement, habitual purchase where the individual has become
accustomed to a specific brand without actively engaging in the decision-making
process. Similarly, their choice of bread or milk might also fall into this
category—purchases made almost on autopilot due to ingrained habits, without
much consideration of alternatives or brands.

4. Variety seeking behaviour

Consumers sometimes change their purchasing behaviour for no reason other
than to try something new. They might be perfectly happy with their brand of
coffee, for example, but just want to see what a different make is like.

Suppose, for instance, a person who regularly buys a specific brand of shampoo
that works well for their hair. However, every few months, without any
dissatisfaction with their current shampoo, they decide to switch to a different
brand just to experience something new. They might have no particular issue
with their current choice; instead, the desire for novelty and curiosity prompts
them to explore other options available in the market.

Similarly, they might occasionally opt for a different type of coffee despite being
content with their usual brand, just to sample a new flavour or blend. This
behaviour is driven by a desire for variety and the experience of trying
something different rather than dissatisfaction with the existing product

Marketing and advertising

Marketing campaigns can prompt customers to switch brands, stay loyal, and
even start buying types of products and services that were previously alien to
them.

Even beyond brand switching and loyalty, marketing shapes consumer

perceptions by associating products with specific values or lifestyles, fostering
emotional connections that transcend transactional relationships. Furthermore,
in the digital sphere, personalized and targeted marketing via social media and
online platforms leverages data-driven insights to tailor messages, influencing
purchasing decisions by aligning offerings with individual preferences.
All the efforts to make an advertisement are cantered on the sole aim of making
it so effective and persuasive in a natural way so as to serve the motto of
meeting the consumer psyche in a positive manner. Every human community
develops a system by which it provides and distributes goods and services. In
today’s advanced societies as the development goes on, this system is becoming
very complex due to wide range of available goods in all fields

Consumer attitude and behaviour hugely influenced by advertisements, as

example Life Good (LG) and Samsung are the brands that are most popular in
Indian market due to the advertisements, on the other hand Onida the old
brand which use to provide huge sales in early 1990’s lacked in sales due to less
advertisements, as per there manufacturing of products with wide range and
less on price, but still not are taste for consumers. This reflect the behaviour
change and attitude formation of consumer as Onida is still providing wide
range of products but consumers only use to go for other new brands due to
their better advertisement strategies involving Sports and Bollywood celebrities
who act as idols in minds of Indian people. Not only durables but food products
and beverages, etc., also get influenced by advertisements. In Asia, McDonald’s
follows cultural habits and uses celebrities. It reflects the behavioural change in
consumers due to advertisements.

Policy and Public welfare:

In policy-making, behavioural economics offers a powerful tool through

nudges—subtle interventions designed to guide people toward beneficial
behaviours without restricting their freedom of choice. These nudges capitalize
on predictable cognitive biases and decision-making shortcuts, often leading to
significantly better economic outcomes at both individual and societal levels.

Economic Implications

Consumer spending is a primary driver of economic growth. By analysing

consumer behaviour, policymakers can gauge the economy's health and
forecast future trends. For example, during economic downturns, a drop in
consumer spending can signal the need for fiscal interventions such as tax cuts
or increased public expenditure to stimulate demand. Conversely, in periods of
rapid economic expansion, policies may aim to curb inflation by tightening fiscal
or monetary measures.

Social Considerations

Consumer behaviour significantly influences social policies, particularly in areas

like healthcare, education, and housing. For instance, a rising consumer demand
for organic foods might prompt policymakers to support sustainable agriculture
or implement stricter food labelling regulations to ensure product transparency
and safety. Similarly, increasing interest in digital education could lead to
investments in technology infrastructure and initiatives to improve digital
literacy, thereby enhancing access to quality education.

Environmental Concerns

The growing awareness of environmental issues among consumers has led to a

shift toward sustainable products and practices. Policymakers respond to these
trends by enacting regulations and incentives that promote environmental
sustainability. This includes measures like carbon pricing, subsidies for
renewable energy, and restrictions on plastic use. By aligning with consumer
preferences for eco-friendly products, governments can effectively encourage
conservation efforts and improve public welfare.

Public Health and Safety

Consumer behaviour is also critical in shaping public health policies, especially

concerning dietary habits, tobacco, and alcohol consumption. For example,
recognizing the health risks associated with unhealthy eating can lead to policies
that promote better dietary choices, such as taxes on sugary beverages or
mandatory calorie information on restaurant menus. Similarly, understanding
the detrimental effects of tobacco use has resulted in stringent regulations on
advertising, packaging, and public smoking bans.

Behavioural Economics in Policy Design

Behavioural economics, which integrates psychological insights with economic

theory, offers valuable tools for understanding consumer behaviour. This field
helps policymakers design interventions that subtly guide individuals toward
beneficial behaviours without limiting their choices. Examples include automatic
enrolment in retirement savings plans or default options for renewable energy
sources, which leverage consumer tendencies to make welfare-enhancing
decisions.

Behavioural Economics Principle

#1: The power of FREE

One of the most powerful words you can use in marketing is “Free”.
That’s why you’ll see supermarkets advertising “Buy one, get one free”, not “Buy
two products, get 50% off”.

While both of these deals are fundamentally the same, consumers will get
a lovely hit of dopamine when they see the word “Free”, and that will be
reinforced when they take advantage of that offer.

A typical example in marketing: Subway

While a lot of brands are moving away from such deals – as customers start to
see through the gimmick – brands like Subway still roll out “Buy one, get one
free” deals for events like World Sandwich Day to get customers through the
doors.
Behavioural Economics Principle #2: Social proof

Social proof is one of the most powerful tools in behavioural economics,

particularly in online marketing. It is the tendency to be swayed by other
people’s choices, especially in ambiguous circumstances.

People are more likely to buy products or services that are popular to gain social
standing amongst their peers, which is why so many consumers read online
reviews in order to gauge how trustworthy a company is – in fact, 81% of
consumers trust a company with lots of positive reviews.

Typical example in marketing: UK government

The private sector is not the only sector that uses behavioural economics
principles in persuading people to take a desired action.

Below is an example of the UK government using the principle of social proof to

encourage more people to become organ donors.

Guess which landing page performed better – 1 or 2?

Yeah, you guessed it. B was the landing page that performed better. Social proof
leads consumers to feel a greater sense of trust in the company, even if this is
the first time they have visited the brand.

Behavioural Economics Principle #3: Scarcity

If you’re familiar with limited edition products, then you’re already familiar with
the power of scarcity in behavioural economics.
Put simply, people tend to put more value on a product if they think there’s only
a limited amount available, or if there’s only a limited window where they can
buy it before it becomes unavailable.

Typical example in marketing: Starbucks

Starbucks is the master of scarcity marketing. We’re all familiar with the hype
around Pumpkin Spice Lattes – and one of the main reasons for this is that
they’re only available for a few months every year.

The coffee giant frequently releases special holiday food and drinks that are
only

available for short amounts of time, with the marketing of these products
revolving around the phrase “Enjoy it while it lasts”.

Behavioural Economics Principle #4: Loss aversion

Humans are more afraid to lose what they have than to gain something they
don’t have.

This basically means that the regret that comes from losing £10 weighs much
more heavily in our minds than the enjoyment that comes from winning £10.

The loss aversion principle tells us that to demonstrate a product’s advantages

to the consumer, we need to highlight what they are set to lose if they don’t
make a purchasing decision.
Typical example in marketing: Amazon Lightning Deals

The best example of loss aversion is Amazon’s daily Lightning Deals. These are
discounted offers that only last for a limited amount of time – 24 hours or less –
and can only be redeemed by a certain number of consumers.

This limitation is the reason why this deals page is so prominent on the website,
as it encourages consumers to make a purchasing decision quickly to avoid
“missing out”.

Behavioural Economics Principle #5: Partial ownership

Almost every successful online membership company offers free trials.

By offering a free trial to consumers, you’re giving customers the feeling of

ownership over that product or service, which develops an emotional
attachment.

When the trial period ends, consumers have to choose between losing the
product or paying to continue the service.

A typical example in marketing: Adobe

Customers new to Adobe can take out a 30-day free trial to see if the software
works for them, which you’d think is a big loss-maker for the company – but it’s
quite the opposite as people get used to using the software and don’t want to
give it up.

Conclusion:

Behavioural economics offers a lens to see beyond traditional economic models

and delve into the emotional, social, and psychological factors that influence our
choices. Specifically, it studies the effect that psychological factors have on
economic decision-making, providing insights into why people might act
irrationally in markets. This field helps explain the complex interplay between
human behaviour and economic outcomes, making it a valuable tool for
understanding real-world economic dynamics.

Bibliography

 www.digivate.com
 www.behaviouraleconomics.com
 www.investopedia.com
 news.uchicago.edu