Psychology and Economics together?
At first, for many people, this union is like water and oil: a mixture just can’t work.
Several researchers, however, have shown that this combination works so well that it brings a new perspective on how decisions are made.
A relatively new discipline called Behavioral Economics results from the union of the knowledge of Psychology with the knowledge of Economics.
What is Behavioral Economics?
Behavioral Economics is a response to the term of classical economics homo economicus. This term states that the human being is endowed with total rationality and all his choices are based on logic and complete reason.
We can define Behavioral Economics as the study of cognitive, social and emotional influences found in people’s choice behavior.
The concepts related to Behavioral Economics seek to explain how human beings make their decisions and were mostly discovered through experiments.
Do we really measure the consequences before we make all the choices? Do we always think about a cost-benefit ratio? Would we be selfish and always put our needs before other people’s needs?
These are just some of the many questions that Behavioral Economics sought to answer.
How do we really make our decisions?
In order to make our decisions, according to the Nobel Prize in Economics Kahneman, we have two systems available: the system (1) fast and the system (2) slow.
According to Kahneman and Tversky in the book Fast and Slow:
System 1 operates automatically and quickly, with little or no effort and no sense of voluntary control. System 2 allocates attention to the laborious mental activities that require it, including complex calculations. System 2 operations are often associated with the subjective experience of activity, choice and concentration. ”
We may not realize it but we are always making choices.
For example, while you are reading, you are deciding whether to continue reading or to close the article tab and open YouTube to watch a video.
Simple as it may be, you are making a choice at all times.
Thinking and pondering choices throughout the day causes us to spend a lot of energy, so most of our choices are made using system 1.
In this way we are able to make most of our decisions more agile. However, when we use the fast system, we run the risk of getting carried away by what we call anomalies. An anomaly is everything that takes our decisions away from rationality.
The anomalies studied by Behavioral Economics are divided into two terms: heuristics and cognitive biases.
Heuristics are mental shortcuts that we take to save time and energy.
Think: how many ways can you take to get home from work?
Even if you have an infinite number of paths, you will always choose the same path. This choice will be a simplification. By always choosing the same route, you save time and energy.
Cognitive biases, on the other hand, are mistakes in judgment of what we do. An example of cognitive bias is called the Framing Effect.
Framing effect is a bias in which the choices are influenced by the way they are presented and it is linked to the Theory of Perspective.
Think about the following situation:
You will undergo a risky surgical procedure and your doctor needs to inform you about the risks.
How do you prefer to be warned about the risks of the surgical procedure?
- () You have 15% of being alive after the procedure.
- () You have an 85% chance of dying from this procedure.
Now think of another situation:
You go to the pharmacy and need to choose a condom from two options:
- () Brand X that presents a 95% risk of not getting pregnant.
- () Brand Y that presents a 5% risk of becoming pregnant.
If you are like most people, you have certainly chosen option A in both cases. That’s because it has been found that people make their decisions depending on how the situations are shown. According to Behavioral Economics, all of our choices are based on comparisons and, therefore, we are comparing at all times – even when it is not our intention.
So what happens when psychology meets economics?
We become more humble by recognizing our limits as thinking beings.
The work of Behavioral Economics is to understand human limitations and what aspects are linked to them. Thus, we can get to know each other better and know the motivation of the people around us. Responding “What we choose” “Why we choose” and “How to change our choices” is the work of the Behavioral Economist.