3 things to know about behavioral economics

What exactly is ‘behavioral’ economics?

In understanding the distinction between behavioral and theoretical economics, it’s important to understand that within the ‘traditional’ view of economic theory, it is assumed individuals behave in a vacuum. In practice, however, the attitudes and wants of individual actors is well, human. In an interview with Yale professor Robert Shiller, Nigel Warburton clarifies this:

So what you’re saying is that traditional economics has focused on a kind of ideally rational individual: what would they do if they behaved in their own best interests based on the information available? But behavioral economics brings in the fact that we don’t always behave in our own best interests.

How can we apply it?

The study of behavior economics has inspired a number of different theories and has been used in many applications. This week we looked at how spending and saving is affected by our predisposition to both. Professor Keith Chen has a theory on our use of language and how it affects our outlook on money.  His TEDTalk, Could your language affect your ability to save money?, examines the derivations of language and how intricacies in verb conjugation may enhance or deprive individuals of an ability to save.

Do futureless language speakers seem to save more? Yes, futureless language speakers, even after this level of control, are 30 percent more likely to report having saved in any given year. Does this have cumulative effects? Yes, by the time they retire, futureless language speakers, holding constant their income, are going to retire with 25 percent more in savings.

What are some applications for the everyday?

How we spend money is affected by uncountable factors: how we were raised, levels of education, how others around us spend their money. One theory derived from behavioral economics is the notion of “mental accounting;” a process the Wall Street Journal labels as the way in which “the human brain, consciously or otherwise, labels and prioritizes money differently depending on where it comes from.” In other words, as consumers, we categorize the items we must spend money on. However, irrational behavior often kicks in when we are making purchasing decisions. The source of money spent often creates dissociation from the reality of spending it. Tax returns, bonuses or inheritance might be spent more frivolously than a typical paycheck as a result of ‘mental accounting.’ Finding an everyday item on sale or more expensive may also lead us to spend more or less in other areas because of the perceived savings or loss. All of which, of course, contributes negatively to our savings rate.

Other applications of behavioral economics include design and policy adaptations. Researchers Saugato Datta and Sendhil Mullainathan have drafted a dissertation on the importance of understanding the gaps left by more traditional views of economic and cognitive behavior. The Center for Global Development says of the study, “Once the problem and actionable bottlenecks have been diagnosed, an intervention to overcome these limitations can be designed.” Studies such as this can help dislodge structural issues that persist in public policy and prevention tactics. As more and more information and research is completed, the findings of behavioral economics may influence much more in our every day lives.

 
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Comments

  • Blackie Gilmore

    Enjoyed this weeks program about helping poor people save money. Bravo to Mayor Bloomberg for being willing to try new ideas to solve old problems. Good guy!