Behavioral Economics and How It Can Impact Your Life

Everything you need to know about behavioral economics and how you can use principles of behavioral economics to benefit your own life. 

What is Behavioral Economics?

Traditionally, classical economics was taught as if human behavior was black and white. Predictions about consumer decisions were cemented in concrete binaries that attempted to describe consumer behavior. In reality however, these predictions gravely missed the mark. They underestimated the complexities of human behavior and thus made for unrealistic modeling. 

The Banana Stand Paradigm

The theory of competition is the perfect example of this. If there is a person on a street corner selling bananas for $2 each, he can continue selling at this exorbitant price because his consumers don’t have options. However, let’s say another fruit seller sets up their stand on the next corner and sells bananas for $1 each. According to traditional economic theory, the first seller would presumably no longer be able to price his bananas at such at $2 because people now have the agency to buy from a lower priced distributor. 

This concept of competition and how it drives down prices for consumers is generally accurate. We see it at work everyday in our marketplace and it is the very foundation of our capitalist system. However, the theory doesn’t always explain all of economic practices. This is because at the end of the day, people’s behaviors are inherently unpredictable. 

Going back to the banana example, people might be deterred from buying at the lower price stand because they believe that higher prices indicate higher quality goods. Thus, many people might continue to buy from the higher priced vendor simply because they believe, whether grounded in fact or not, that the quality of the bananas are better.

Alternatively, but equally as possible, people might have gotten into a routine and identify the banana stand as their stand and, though prices somewhere else might be cheaper, they do not want to interfere with habitual routine that has proven successful for them. This relates to the inherent opposition to change that many people experience. They might have a relationship with the higher priced vendor, perhaps he is the son of a family friend or a neighbor, and thus feel an obligation to remain a loyal customer regardless of price. 

All of these reasons and more only begin to introduce the complexities that are ignored when relying solely on a classical economics theories. The inherent flaw in relying on classical economic models is that they expect consumers to be completely rational and always make decisions based on logic. However, in reality, people have many other factors that cloud their judgement and complicate the decision-making process, for better or for worse. Classical economics theories don’t take into account the emotions, ability, time, or access to information that contribute to a consumer’s decision. 

To be clear, this is not to say that classical economics models should not be used. These models provide the crucial broad-scoped picture of how humans behave and make decisions to a certain extent. However, incorporating behavioral economics principles provides a more holistic picture and introduces vital nuances that provide insight into making the mysteries of consumer decisions less unpredictable.

De-Mystifying the Unpredictable Consumer

Bounded Rationality