Question

Behavioral Economics

a. Why did economists start studying behavioral economics?

b. Name & explain the 5 principles of behavioral economics.

c. What is Nudge Economics and site an example illustrating the concept?

Answer 1

Solution

Behavioral Economics refers to the study of the effect of human psycological factors on their economic decision making.

It has become very important these days for multiple sections of professionals because of multiple reasons

- For Marketers to understand the human behaviour behind their economic choices so that they can design and target their marketing campaigns to a particular consumer segment ; create a proper value proposition in line with the needs of their target customers.

- By researchers and also different professionals so that they price their products accordingly in the market.

- To understand the consumers and also the competition in various industry.

a.Economists have started studying the behavioral economics because they want to understand the human behavior and rationale of different sections of people while taking their economic decision under different situations so that they can pass on the information to the regulators and the federal & state govt. which would be considered while drafting ,implementing and also tracking the progress of the various economic policies of the governments.

b. 5 principles of behavioral economics :

(i) Power of free - This concept infact masks the output of the concept of reducing the price differential between the 2 goods in order to reverse the economic decision taken to choose one between the two.

Ex: Of Good A and B cost $2 and $ 6 each. People generally go with B if it is a much superior brand, instead of going with B.If prices of both of them are reduced by $1 each then some customers switch the sides.But reducing the prices by another $1 by making A is free and B for $13 the scene reverses - There is a massive customer switch from B to A. even though the price differential between the same remains the same.

(ii) The pain of cost - The cost of doing payment should be proportional to the amount payed. Ex: Especially in the case of purchase of high ticket vehicles like cars and trucks,the dealers always would encourage the customers to purchase it on loan.This is because there can be delay in payment which would increase the customer's willingness to purchase the vehicle.

This technique works as people think that delaying the payments make the value of money less costly.

(iii) Dominated alternatives - Providing the alternatives in such a way that one of the alternatives is worthless thereby creating a feel that the other alternatives have the real value in them.

Ex: For Example - Consider 3 alternatives for a subscription stock recommendations

Option 1 - Online subscription - $56

Option 2 - Online + Print Subcription - $ 125

Option 3 - Print Subcription - $ 125

Here the dummy / useless  option 3 is created to increase the value offered by option 2. So,ultimately the sales of Option 2 will increase which is the exact outcome the company desires.

(iv) Nudge Economics - People tend to misunderstand / misjudge about the true value of a good/service.They tend to believe that cheaper stuff tends to be inferior in quality and vice versa.

(v) Decision Paralysis - Reducing the number of available options to the customers will increase the sales.

c.Nudge is a technique that involves some positive reinforcements and suggestions in order to change the consumers behavior in a low-cost and a easy way.

Nudge economics deals with various techniques that create this kind of impacts.

Ex: Labelling the harmful ingredients on a product - This will inhibit the customer to think before making the choice of purchasing the product Ex: Indian Govt.makes it mandatory for the manufacturers to put a Big Warning and a picture of infected lungs on every packet of cigarettes in order to discourage smoking.