PSYCHOLOGY: CLASSICAL ECONOMISTS think of the average consumer asan inherently rational being who weighs up all the options in acalculating manner and then comes to a well thought-out decision.
This rational consumer would never buy travel insurance theydidn't need when booking a flight; they would never stay with autility provider despite cheaper options; and they certainlywouldn't drunkenly fire up the internet at four in the morning witha credit card in hand, just because someone at the pub reminded themof the existence of Swedish rockers, Roxette.
Over the past couple of decades behavioural economics has begunexamining the underlying psychology of our financial decisions, andis beginning to amass an impressive amount of data about how realpeople operate, rather than idealised ones.
"We're starting to understand a lot more about people'sbehaviour," says Pete Lunn, a behavioural economist with the ESRIand author of Basic Instincts.
"We're beginning to see that it's not the way we long assumed itwas, particularly not the way professional economists assumed itwas." This has implications for how politicians and economistsregulate and model future behaviour, but also for how we manage ourown consumption. Some of the insights coming from behaviouraleconomics have been known intuitively by marketeers and advertisersfor decades.
We like to follow the crowd, we favour familiarity (and so tendto prefer well-known but inferior brands over superior newcomers),we tend to go with default settings rather than making individualchanges and we instinctively put all our eggs in one basket (hencethe property bubble). However, even the marketeers underestimatedjust quite how irrational we actually were. Pete Lunn is filled withexamples.
"If you offer people a cash discount for paying in cash insteadof plastic, a certain proportion of people will pay cash and get thediscount," he says.
"However, if you change it so that it's exactly the samesituation but you call it a 'credit card surcharge' suddenly theproportion of people who do it will radically alter. Very few peoplewill be willing to pay the surcharge and they will put in the effortand will pay in cash instead. But it's basically the same decision."
Lunn gives another example: "If you set up two products in arange - product A and product B - and A is cheaper than B, youusually find most people are buying the cheaper product but a smallnumber are buying the more expensive product. It's maybe a 70/30split. However, if you introduce product C - a more expensiveproduct again - suddenly more people will buy product B over A.Instead of 70/30 for A over B, it could be 70/30 for B over A. It'sthe same decision but it's framed differently."
Lunn calls these subtle differences "framing effects" and he isaware of 70 to 80 common such framing effects.
When the framing effects change, the same scenario looks, to theaverage consumer, like a very different decision. What thesehighlight, is that the typical consumer doesn't focus in on thedetails of individual choices but tend to use general rules of thumbwhen making our decisions. These rules of thumb the experts call"heuristics".
"Following these heuristics is not an entirely irrational thingto do," explains Liam Delaney, an economist from the Geary Institutein UCD, who is currently spending a year at the Woodrow WilsonSchool in Princeton, the Mecca for behavioural economists.
"A German psychologist called Gerd Gigarenzer called them 'simpleheuristics that make us smart'. They're basically cultural rules weuse to navigate complexity and which have built up over generations.They make sense in that without them, you could spend every minuteof every single day trying to calculate everything. We wouldn't havegot out of the evolutionary environment without quick ways of makingdecisions and heuristics work very well in many contexts. It's justthat there are instances in modern life when they don't serve us sowell."
Delaney and Lunn both argue that it's almost impossible to fightyour programming on every little purchase, but that it's veryimportant to do so with the big life decisions.
"I still catch myself making the kinds of dumb decisions I readabout every day," says Lunn. "But people use the same decisionmaking processes for the big stuff, and that's where it's moreworrying. Does it matter if people are losing a few cent on beansevery week? Probably not. Does it matter if they're taking up thewrong pension, or taking up no pension at all? Yes, it does. Does itmatter if they're buying overpriced houses because everyone else isdoing it? Yes it does."
Indeed, it's on the big ticket issues that behavioural economicswill soon start influencing public policy. Both Barack Obama andDavid Cameron are listening closely to the behaviouralists, andbooks like Nudgeby Richard Thaler and adviser to the Obamaadministration, Cass Sunstein, suggest that government has a role inshaping the "decision making environment" particularly around issueslike mortgages, health insurance and pensions. In the UK, forexample, the government is using behavioural insights to fight thepension gap. Psychological experiments show that people favourdefault options, and so in 2012 workers will be automatically optedin to company pension schemes. They will then have the option to opt-out, but most, the behaviouralists argue, will choose the default.
In the US, behavioural economists helped devise Obama's stimulusplan - supposedly framing it in such a way that encouraged spending(aka stimulus) rather than saving.
For some this is worrying. And if you're one of those peopleworried by the prospect of being gently nudged and second-guessed bythe government (advocates of this type of governance call it"libertarian paternalism"), then you might be even more worried bythe fact that marketing companies are increasingly learning aboutthis stuff as well.
"Some feel it will be the rejuvenation of the marketingindustry," says Lunn. "Others find this terrifying".
And the insights are going deeper. Richard Roche, aneuroscientist based in NUI Maynooth has for the past few years beenworking with behavioural psychologists such as Liam Delaney touncover the neural processes underlying economic decisions.
"Neuroeconomics is a relatively new thing," says Roche. "We'relooking at what's happening in the brain when people make financialchoices under different circumstances. It can help prove or disprovewhat economists think is happening." Although it's a new field,Roche ultimately feels that what we learn from both behaviouraleconomics and neuroeconomics could help us become wiser shoppers. "Ithink in allowing people become more aware of how they makedecisions it will help them make better decisions," he says, but healso tells me about a new area called neuro-marketing, "where theybasically put people in scanners, present them with brand names andlook at their reactions".
Taken as a whole, behavioural economics and neuroeconomics arefascinating new fields that will help us to better understandourselves and our financial decisions. They will also, of course,help others to better manipulate us.
Thinking traps that affect our decisions:
LOSS AVERSION
People are more motivated by fear of a loss than hope of a gain,hence are more likely to seek to avoid a penalty than seek to gainbonus, even if both amount to the same thing.
ILLUSION OF CONTROL
For example, people feel an illusion of control when they'reallowed pick their own lottery numbers, even though they are no morelikely to win by being given this choice.
DENOMINATION EFFECT
The tendency to spend more money when it's denominated in smallamounts (like coins) as opposed to large amounts (like large notes).
ANCHORING
Once a specific anchor is implanted, other important details getoverlooked in decision making. So, if buying a car, people might gethung up on the year of the car, or even the colour of the car,rather than other more pertinant issues, like well it's beenmaintained.
MONEY ILLUSION
There's a tendency to think of currency as having a real valueunlinked to its purchasing power. So, in experiments people think ofa 2% pay cut as unfair, but a 2% rise in income where there's been4% inflation, as fair.
REACTANCE
Basically reverse psychology. Marketing professionals oftenplaster games packaging with warning labels and age prohibitionsknowing this will make some more eager to buy them.
POST-PURCHASE RATIONALISATION
People will overlook problems with a product to justify theirdecision in purchasing it in the first place.
BANDWAGON EFFECT
The tendency to do or believe something because many others aredoing or believing the same (anyone who fell foul of the propertybubble will be familiar with this).
No comments:
Post a Comment