Throughout history, it has become increasingly more clear that humans do not always act as rational, self-interested beings. In fact, there are many cases in which people do not act in rational ways. Richard Thaler, a recipient of the 2017 Nobel Memorial Prize in Economic Sciences, refers to this as there being Humans and Econs. To elaborate, an Econ is what the standard, orthodox model of economic thought describes people as. Econs are rational, they are self-interested, they are autonomous, and they maximize their personal utility (or satisfaction). However, Humans are not rational. They discount the future in regards to money, they value money in different ways (money in a 401k is not viewed the same as money in a checking account), and they are sometimes altruistic. Neoclassical economics does not look at Humans. The theories are based largely on those of Econs. Hence, the field of behavioral economics was born.

Richard Thaler is considered to be one of the leading foremen of behavioral economics. Behavioral economics is a method of economic analysis that utilizes psychological insights into human behavior to help explain economic decision making. This means behavioral economists consider psychological reasons as to why an automatic enrollment into a 401k plan (with an opt-out provision) has a better enrollment rate than an out-in 401k plan. Econ man would never need an opt-out 401k because Econs are rational beings. However, humans are not.

People are largely loss-averse. Losing $100 feels much worse than gaining $100 feels good. In addition, people often are enticed by sales. An example would be if one goes to the store and sees that all size quilts are on sale for $150. If someone has a twin sized bed, they are more likely to purchase the king sized quilt simply because it is the same price and it feels like a better deal. Econs would never purchase a too large quilt simply because it was the same price as the size they actually needed.

Behavioral economics has policy implications. It has been found that nudges are helpful and very cost-effective. A nudge is something that alters people’s behavior in a predictable way without forbidding options or changing economic incentives. For example, having a 401k be opt-out rather than opt-in is considered to be a nudge. A simple line of text in a tax collection letter such as “A majority of taxpayers in this state paid on time” is considered a nudge. A text reminder to take one’s medications is considered a nudge. These are all things that people would like to do. People largely want to contribute to 401k’s, especially if there is an employer match. Unfortunately, laziness or fear of paperwork and investment decisions largely takes over and it gets put off. People want to take their medications, especially since they are so expensive, but frequently forget. Text reminders have been proven to be effective in reminding people to take their meds. This is helpful to doctors, as well as pharmaceutical companies.

All in all, behavioral economics makes the discussion of economics more digestible and human. Frequently, economic man is unrelatable. People do not always make good choices, sometimes people need a nudge in the right direction. It is important to note that nudges are not aggressive or forceful. A good example is that banning cigarettes is not a nudge. Increasing taxes on cigarettes is. This is because people still have an option to purchase cigarettes but due to a price increase, they will likely think harder about quitting.

 

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