Behavioural economics is a fairly modern economic theory, it
accounts for the fact that humans do not always behave ration-
ally in a way that maximises satisfaction for every pound spent
on each product bought. It considers the social, moral and phys-
iological factors that determine our actions. There are a few key
aspects of this theory:
1)
Bounded Rationality
This is the concept that people do try to behave rationally but
are restricted in their ability to do so, this could be for many
reasons such as: a limited ability to process and evaluate every
piece of information, the available information is inaccurate or
out of date (this is a market failure known as information failure
or inaccurate information), the impact of emotions on decision
making, or the time to make decisions is limited. The result of
this is that we can end up making satisfactory decisions, rather
than the most advantageous decisions.
2) Bounded Self-Control
This is the theory than individuals have good intentions but do
not have the ability or the self-discipline to see their rational
intentions through. Some examples of this are, saving money for
the future, stopping drinking alcoholic beverages or quitting
smoking. This is caused by human wants and the need to satisfy
these wants instantly. This irrational behaviour leads to people
with even the best intentions to end up accepting sub optimal
outcomes. Consumers often do not stop consuming even when it
makes sense to stop, for example, extreme investment in a par-
ticular stock or share.
3) Rules of Thumb
Rules of thumb can also be known as heuristics. These are
thinking shortcuts or educated guesses made by an individual to
make decisions in order to save time or exertion involved in the
rational decision making process, this is closely linked to bound-
ed rationality. Many people fall back on "tried and trusted" heu-
ristics when making their decisions and choices. For example a
person may always choose to purchase the same meal at a res-
taurant because they have enjoyed it previously, this saves the
consumer time and effort making a comparison on every visit to
the restaurant.
4) Anchoring
Anchoring is a tendency for individuals to rely on certain pieces
of information, in situations where they lack knowledge or ex-
perience. An anchor is any aspect of the environment that has
no direct relevance to a decision but still affects people's judg-
ments. For example when choosing car insurance a consumer
may just focus on price to compare instead of focusing on ex-
cesses and exclusions of policies. A famous example of anchor-
ing is the credit-card tip system operated in New York taxis.
This credit card system suggested a 30, 25, or 20 percent tip.
This made passengers think that 20 percent is as a low tip
whereas the average previously was only around 8-10 percent.
5) Availability
The availability bias is when consumers make verdicts about the
probability of events based off recent instances. This happens
when consumers often judge the likelihood of an event, or fre-
quency of its occurrence by the ease with which examples come
to mind. For example, going out to buy sun cream on the first
day of summer or buying warm clothes and hats and road salt if
Seven Key Principles of
Behavioural Economic Theory
Olivia Bollington
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