Traditional Economics was largely concerned with the rational behaviour of the “Economic Man” and market efficiency. It was assumed that consumers always make decisions that optimise their benefits. For example a consumer would always buy a commodity till its marginal utility is equal to its price (satisfaction derived from the last unit of a good consumed will always be equal to the price paid for that unit of a good). If the utility is less than the price, the consumer will buy less units of a good and the utility is more, the consumer will buy more units of a good. Like consumption, even while making other economic decisions, rationality was assumed to be prevailed. The later part of 19th century especially paved the way for this assumption of rationality and methodologies in pure sciences for analysing the economic behaviour. Economists like Gary Backer in 1960s even applied this assumption of rationality for analysing the choices with respect to crime, marriage and many others.
But “Is human behaviour always rational?” Many scholars during the same time period were coming up with different approaches for analysing the choices made by the people. Herbert Simon, Danial Kahnamann, Amos Tversky and some other thinkers were trying to understand the irrational choices affecting the decision making by the individuals. In 1950 Herbert Simon came up with the theory of “Bounded Rationality” wherein he established that individuals may not always optimise on their decision making using the usual cost and benefit approach. Rather people are rational within a framework.
This idea of bounded rationality later on influenced many scholars. Psychologists and many economists were also trying to understand this human decision making by considering factors like availability of information, ability to weigh costs and benefits, external and internal environment, peer thinking etc. It was found that the Theory of Rationality as given by Gary Becker did not always hold true and rather decisions made by the individuals could be different than what is perceived to be optimal.
The real change with respect to the thinking towards decision making came with the “Prospect Theory” given by Daniel Kahneman and Amos Tversky. According to them based on the situation prevailing or in their own words “context” people arrive at a decision and this decision may not be always most optimal. Later on Richard Thaler emanated many other aspects of behaviour which influence the economic decision making. Thaler who won the Nobel Prize in the field of Economics in 2016 is considered to be the father of Behavioural Economics. The pioneering work of Kahneman and later Thaler led to the beginning of new branch in Economics called as Behavioural Economics. This new branch uses psychological aspects of behaviour to understand economic behaviour of individuals and based on that also suggests policy solutions to alter the behaviour using the “Nudge Theory”.
Thaler observed that people consider various aspects while spending money, buying commodities etc. People always have different types of “accounts” in their minds for different expenditures. Based on this “mental accounting” they actually incur expenditure. This may not always involve ‘wise’ decision making. Also there is an element of “fairness” when decisions are taken. People will deliberately not take decisions that will harm others. Lastly individuals may not have “self- control” while buying the goods and services.
Few experiments undertaken by the scholars throw light on this consumer behaviour. If the choices are presented in a different way and people are allowed to have freedom to choose, it alters the human behaviour. The experiments conducted with respect to the choice between healthy food and junk food show the behavioural aspects of economic decision making at the individual level. If healthy food is rearranged in shopping malls, canteens etc. and it is more visible and accessible than the junk food then this provides a Nudge (positive influence) that influences people to buy more of healthy food.
The Economic Survey of India 2019-20 also mentions the importance of nudges to alter the behaviour of people with respect to the use of toilet under ‘Swacch Bharat Abhiyan’. Survey found that when toilets are built in the rural areas and neighbours start using it, it leads to the positive changes in the others people’s behaviour.
In the last decade, the scope and use of behavioural economics has expanded tremendously across the world. United Kingdom in 2010 established the first Behavioural Insights Unit under the cabinet office. Later on USA, Canada, Australia and many other countries started using the insights of behavioural economics for policy making that will positively influence the choice making of the people. The policies related to financial investments, health, use of resources, poverty are increasingly being formulated with the insights from the behavioural economics.
Different governments are now employing people having the background of this branch for policy formation. Lot of researchers are required to understand the human behaviour using the interdisciplinary fields of psychology and economics. There is a need of forming policies in the field of public health (epidemics, lifestyle diseases like diabetes, obesity) with the expert analysis. Behavioural finance is a field where experts in financial markets analyse the investment decisions and how would people choose various investment options based on the risks and uncertainties. They help the people in minimising their losses. The working of financial and other markets can be understood very well with the help of such experts.
But there are many limitations of behavioural economics. The stream depends mainly on experimental analysis; many times in controlled state. For a large section of population, nudges may not work. People may not always be irrational while taking decisions. Hence excess reliance on these experimental techniques may not always provide good policy insights. Irrespective of this the new branch of economics has definitely provided an alternative theory to understand human behaviour and policy formation.
In Thaler’s words: To wake up – A nudge is sometimes all we need!!