When subtle nuances of the human psyche knock on the doors of economic conjectures, there are few takers. What a robot-like rational individual does, bound by many a dismal assumption may be in harmony with theories, but in actuality there is a gaping chasm between the regular guy and the economics puppet.
Rationality has always found a place in the subject matters of economics. Reason and stone-cold logic feel at home in neoclassical theories. But psychological insights have been continually sidelined. This is precisely where Economics needs to come in conjunction with something more perspicacious and offer a more holistic overview. Till about fifteen years ago, the sub-discipline called Behavioral Economics– the study of how real people actually make choices drawing on insights from both psychology and economicswas a trivial extraneous endeavor. Today however, it is a recognized and fast growing discipline with immense scope for research.
This economics puppet, the Rational Man, will stop betting at a casino when he expects to lose. This Rational Man will save for retirement, eat better, start exercising and quit smoking. When he is a victim who has been treated poorly, he will not exact revenge because doing so will hurt his own interests. This man will indulge in no self-sabotaging or even altruistic behavior. The actual human being, on the other hand, ah well does no such things.
A lot of the decisions that the regular man makes depend on how the choices available to them are framed. Some marketers use a decoy choice to introduce a different reference point which influences the decision that consumers make. Suppose students are given two choices. The first choice is an online subscription to The Economist at 100 rupees. The second choice includes both print and online version together at 250 rupees. Since students like to save money, most will opt for the first option. Now lets say they are given three choices. The first is the same. The second is the print-only option at 250 rupees and the third option is print plus online at 250 rupees. Interestingly, because print-only becomes a reference point, the majority of the students choose the print plus online option. Imagine how you can utilize this decoy effect to increase sales at say, a burger company. All you have to do is introduce three options, one being a decoy.
When the I Pad was launched, a lot of on-going speculation about the price resulted in the dominant price coming out to be 999$ in the media. Then at the launch, Steve Jobs says, Whats the price going to be? He puts up a slide with 999$. Then there is a crash and the figure 499$ appears. The 999$ wasnt just a gimmick. Our man Jobs was using the anchoring effect to his benefita tendency to use an initial piece of information to make subsequent judgments. So when the audiences gaped at the high price of 999$ feeling a virtual hole being burnt in their pockets, it was a relief to see the actual price be comparatively as low as 499$ which though in itself is extremely steep a price.
In another anchoring experiment, 55 students at Massachusetts Institute of Technology (MIT) were asked to write down the last two digits of their social security number. Then, they were asked to guess the price of a mouse. What happened was that students with last two digits between 0 and 20 guessed 8$ and the ones with last two digits between 20 and 100 guessed 26$. Why the difference? The last two digits of ones social security number are arbitrary so in a utopian case, they shouldnt matter. But when the only information that has been provided is these digits, then the students start counting down and thinking about how much they should adjust. In one case, they adjust downwards from 20 and in another, they adjust downwards from 90, which accounts for the difference.
Another intriguing concept that has baffled stern economists is the Endowment Effect which says that people, normal people and not robots designed to suit economics convenience, value things they already own more than identical products that they dont. So the resplendent blue bag you own might be worth a lot to you but when you put it on an online sale portal there wont be buyers who value it as highly as that due to lack of any attachment to it. This puts the conventional concept of valuation into questioning because ideally it shouldnt be affected by ownership. Similarly, the value you connect to a product before and after you have purchased it should remain the same. However, it really isnt and hence the need for a more flexible science that understands behaviors and economics wholly and jointly.
Like most transformations in prevailing notions of wisdom, this one too will have to wait for its time. Inundated with novel ideas, strange yet pertinent facts, and observations that pave way for a more inclusive science that strives to take into account the flexibility of human thoughts and actions, Behavioral Economics is imminently close to achieving its moment of glory.
Meghna Yadav
Shri Ram College of Commerce