Richard Thaler, the Nobel Prize-winning economist who is considered the founder of this influential field, defined behavioral economics as “the combination of psychology and economics that investigates what happens in markets in which some of the agents display human limitations and complications.” Whereas traditional economics (known as the “standard economic model”) assumes that people are rational actors whose decision-making in the market is based purely on calculations of costs and benefits in pursuing one’s preferences, behavioral economics identifies important ways that this theory is challenged in reality by cognitive biases.
For example, individuals often lack the willpower to make choices in their long-run interest, even if they rationally understand the costs. People also often make altruistic sacrifices to help others, in contrast to purely rational actors that pursue only self-interest. These types of insights from psychology have been deepened in recent years by bringing in advances in our understanding of how the biology of the brain works, creating the closely related subfield of neuroeconomics.
These insights may seem like common sense, but they have important implications for business. Behavioral finance has helped explain how the stock market is influenced by biases such as “loss aversion,” which leads investors to fear losing money more than they value gains. Consumer neuroscience has yielded marketing insights on how memorable branding builds associations in the brain that impact purchasing decisions.
Behavioral economics and related fields can seem to some like an effort to “hack” the human mind for financial gain, particularly when used in marketing. However, leading theorists in this field such as Thaler have demonstrated that this experimental, science-based approach to economics can also help policymakers come up with policy interventions to “nudge” people towards making better long-term decisions such as eating healthier food and saving more of their money.
