Behavioural economics and economic policy

Behavioural economics has become increasingly influential in helping to shape a range of economic policy. Perhaps its strongest appeal is that the ideas and insights gained from research can be applied in a very wide range of contexts where policy-makers might intervene.

Choice architecture

Choice architecture relates to the symbols and signals that are present at the time that individuals make choices. For example, in deciding to purchase a financial product an individual is likely to be influenced by physical surroundings, promotional materials, posters and what the 'choice architect' is saying or suggesting. It may be that the environment in which economic decisions are taken is weighted heavily in favour of the seller, who may lead the buyer towards the decision that is most favourable to them. If policy makers consider this to lead to a sub-optimal decision, such as taking out a loan when the individual really cant afford it, then interventions can be made to prevent this decision making bias.

For example, policy makers may pass legislation to insist that there is a time-delay between discussing the product with the salesperson, and being able to sign the contract, or having a 'cooling off' period after the signing of the contract.

Decision framing

Decision framing is structuring an environment so that individuals arrive at a decision that yields the seller, of the policy-maker, the most optimal result. For example, websites selling subscription packages will typically have three prices reflecting different levels of service provision. Option one is usually 'basic' with fewer options, but is the cheapest; options three is the highest level of services, with, often, an excessively high price (which few will choose), and option two is the mid-range and mid priced option, which seems 'good value' compared with the very high price.

Decisions are being framed in such a way that option two is the favoured option, and - crucially - more people are likely to make a decision to purchase when they feel they have a choice. So, offering just the single price (option two) would lead to fewer sales overall.

So how can these approaches be used by policy makers?

Policy applications

Nudges

Behavioral economists suggest that policy makers can adapt some of the theories developed to nudge individuals towards making rational choices. A nudge is a small push towards making a 'wanted' choice or avoiding an 'unwanted' choice, and often involves manipulating the choice architecture and environment. For example, by forcing retailers to hide cigarettes behind sliding screens, some who have never smoked may be nudged away from smoking.

Nudges are unlikely to work on their own, and are more likely to be successful in combination with other, perhaps more traditional measures, such as taxing unwanted behaviour and subsidising wanted behaviour.

Mandated choices and restricted choice

Many of these suggestions have been incorporated in legislation, especially relating to financial services and complex financial products.

In terms of restricted choice and government policy, options may be limited so that, along with other policies, individuals are encouraged to choose the most suitable option for their circumstances. For example, if operating an urban road pricing scheme, drivers may only be allowed to travel into the city on either a Saturday or Sunday, but not during the week. They have to enter their license plate into a website, and state which day they are travelling. There is a choice, but it is restricted. Of course, they could also choose not to travel.

However, with mandated choices, individuals must make a decision - there is no option which involves not making a choice. The theory behind this is that individuals often delay making choices, cannot be 'bothered' or simply avoid having to think. For example, individuals investing in stocks could be forced to complete a questionnaire explaining the risks before they are allowed to complete their investment, and cooling off periods to allow individuals to reflect on their decision.

As with all aspects of behavioural economic theory, critics argue that the approach can be excessively paternalistic and that there may be unintended consequences, perhaps arising from poorly designed policies. It can also be argued that the manipulation of individuals to make certain decisions is unethical, and that repeated nudges deadens the ability of individuals to make their own choices. [2]

[1] Behavioural Economics, in Competition and Consumer Policy, Centre for Competition Policy, Economic and Social Research Council Edited by Judith Mehta, University of East Anglia, 2013, viewed August 1, 2021 https://competitionpolicy.ac.uk/documents/8158338/8193541

[2] Puce, L, Journal of WEI Business and Economics-2019 https://westeastinstitute.com/journals/wp-content/uploads/ 2012/08/176-Liga-Puce-Ready.pdf