Behavioural Economics: Not a Magic Wand, But Can Free Policy Makers from Theory

Published on: 2017/10/26

SA Raghunathan


Using behaviouralism, it should be possible to evaluate better, costs and benefits of social sector projects in education, healthcare, water, sanitation.

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Behavioral economics, policy making

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Behavioural Economics

Behavioural economics, in simple term, refers to the psychology of individuals and institutions in the decision-making process of the economy. According to the neoclassical economic theories, behavioural economics, in a situation of scarcity, humans tend to make choose an option that would maximize his satisfaction. They are rational in order to maximize their self-interest.

The modern theory suggests that behavioural economics is based on the study of human psychology and economics. It is a study which explores why an irrational decision is taken some time. Why humans choose choice B instead of choice A. Sometimes this irrational decision may not be how it was predicted through economic models. The rational theory does not consider the emotional and other distractions that humans get influenced about. The decision-making process of humans get influenced by a lot of other factors like what an individual perceives, his emotions at a given time and also other social influences.

7 principles of behavioural economics (1)

  1. Other people’s behaviour matters:

People strongly get influenced by the way other people feel about the actions that are done by them. Policymakers should consider the social norms while devising a system which would have a medium – long-term effect.

  1. Habits are important:

There are so many things that individual does without consciously thinking about them. These habits remain with the individuals even if they try to change. Policymakers should consider the habits of the people. Are the habits likely to hinder behavioural change? Should there be a financial or non-financial incentive to bring about a behavioural change?

  1. People are motivated to ‘do the right thing’:

In many cases, people feel insulted if others pay for it. For example, for volunteering work, it may be demotivating if there is a monetary reward. Policy makers should consider how people perceive the behaviour that they are trying to change.

  1. People’s expectations influence how they behave:

People have different values and commitments. They want their actions to be in line with these. Policymakers should assess the practicality of getting people’s commitments. The commitments can be written or oral, public or group commitments.

  1. People are loss-averse:

People tend to avoid losses and they may take large risks to avoid loses. At the same time, they may not take small risks to gain something. They hang to something that they consider to be “theirs”. For example, in the case of tax collection, when collected at the source, it may cause less resentment than when collected later.

  1. People are bad at computation

People tend to forget what took place some many years ago. For instance, the recent events may have more influence on their behavior that ones that happened years ago.

  1. People need to feel involved and effective to make a change:

When things go beyond the control, people feel helpless and incapable. When they are in control, they are highly motivated. At many times, even monetary benefits or incentives may not bring the necessary change. Policymakers should be aware that giving too much of information can become counterproductive. The target should not be overwhelmed with any information or regulatory norms.

Read more: Behavioural economics: Not a magic wand, but can free policymakers from theory, by financial expert SA Raghunathan.