Behavioural economics
Seven key principles from behavioural economics and psychology which highlight the shortfalls in the neoclassical model
22 September 2005
Standard neoclassical economic analysis assumes that humans are rational and behave in a way to maximise their individual self-interest. While this ‘rational man’ assumption yields a powerful tool for analysis, it has many shortfalls that can lead to unrealistic economic analysis and policy-making.
This briefing distils many concepts from behavioural economics and psychology down to seven key principles, which highlight the main shortfalls in the neoclassical model of human behaviour.
The seven principles:
- Other people’s behaviour matters: people do many things by observing others and copying; people are encouraged to continue to do things when they feel other people approve of their behaviour.
- Habits are important: people do many things without consciously thinking about them. These habits are hard to change – even though people might want to change their behaviour, it is not easy for them.
- People are motivated to ‘do the right thing’: there are cases where money is de-motivating as it undermines people’s intrinsic motivation, for example, you would quickly stop inviting friends to dinner if they insisted on paying you.
- People’s self-expectations influence how they behave: they want their actions to be in line with their values and their commitments.
- People are loss-averse and hang on to what they consider ‘theirs’.
- People are bad at computation when making decisions: they put undue weight on recent events and too little on far-off ones; they cannot calculate probabilities well and worry too much about unlikely events; and they are strongly influenced by how the problem/information is presented to them.
- People need to feel involved and effective to make a change: just giving people the incentives and information is not necessarily enough.
Our aim is to change the analytical framework for policy as well as to maximise the impact of policy interventions. We also hope to reduce unintended outcomes arising from making decisions based solely on a neoclassical economic analysis.
