The Article below was assigned to one of this year’s summer interns, Xara Smyth, and was written with the close supervision of our Team. Xara is about to enter year 2 at Warwick University, UK, where she is studying the degree of “Politics, Philosophy and Economics”. Ultimately, it has provided an opportunity for Xara to enhance and outline her knowledge on paper regarding the very interesting subject of Behavioural Economics. On the other hand, our Company has gained insight from an informative, topical and at the same time academic piece of writing, circulating around a matter of utmost importance in the modern era. It is certainly an enlightening piece of writing and a quick, pleasant read for everyone.
Behavioural Economics:
Behavioural economics is the “science of judgmental heuristics”, explaining the mental shortcuts behind the making of a decision by intersecting the fields of psychology and economics (Furnham, 2011: 35). It creates a deeper comprehension of the how and why people make choices. When in traditional economics it is assumed that the individual is rational in decision-making, behavioural economics looks into the emotional and psychological factors. In doing so, it can explain the seemingly irrational choices that individuals make; such as buying overpriced goods just because they used to be even more overpriced in the past.
This article focuses on the default effect and anchoring effect. Both effects fall under the category of ‘choice architecture’; the process of framing choices in order to guide a decision-maker in a certain direction.
The Default Effect:
Defaults are pre-selected options that are paired with a decision. They decide the answer to the decision before you make it, and you have the choice on whether or not to deviate. The default effect implies that people are more likely to conform to a decision that is already made for them than they are to make the decision independently. It is a branch of Nudge Theory, which states that small nudges – such as a pre-made decision – can lead to disproportionately advantageous results (Sunstein, 2017). For example, this could mean that by making online receipts the default choice as opposed to paper ones, the amount of paper wasted by a particular company is drastically minimised.
The cognitive mechanism behind this is the status quo bias. Humans are naturally inclined towards a cognitive economy, whereby they may conserve and reduce their mental energy. When it comes to making a decision, due to this natural inclination, people are overwhelmed by large amounts of choices when they have to come to a conclusion. Therefore, in the situation where a default choice exists, the call for deliberation and comparison is reduced; an easier option is presented. Any fears of regretting the decision, or fears of change and the uncertainty it brings with it, are reduced. Therefore, default choices nudge us towards maintaining the status quo.
A good illustration of this is the policy of either opt-in or opt-out organ donation across countries. This is the difference between explicit consent (opt-in) and presumed consent (opt-out). Statistics show, as in Figure 1, that countries with an opt-out policy have higher rates of organ donation than countries with an opt-in policy (Molina-Pérez et al. 2021). The data concludes that when people are automatically registered to donate their organs, they are more likely to agree to it than people who have to go out of their way to sign up to it.
Policies such as these can be used by politicians, economists, et cetera, to guide the population into making certain choices. If used correctly, it can be applied to encourage outcomes that are beneficial to society, such as sustainability through the reduction of paper waste, or higher amounts of organ donation. However, if used with amoral intentions, it can guide people towards making choices that are not the best for them – such as spending more money than what is necessary, or what something is worth.
The Anchoring Effect:
The anchoring effect is when people rely disproportionately on the first piece of information they receive and let it sway their decisions, even if it doesn’t make sense. For example, if someone suggests a price for something, we might get stuck on that price and base our choices around it. We naturally assume that the suggested price is a good starting point, and then we find ways to connect our decisions to that initial suggestion, bringing up related thoughts in our minds (Furnham 2011). However, this is not always right, and brings to mind the widespread phrase: “assumption is the mother of all mistakes”.
Empirical evidence carried out by Critcher and Gilvovich (2008) supports that even so much as the number on an athlete’s jersey can act as an anchor for estimations of his performance; proving that even unrelated numbers can act as anchors. This is another exemplification of the cognitive economy. By basing judgments around an initial, often irrelevant number, we reduce our mental ability and independent cognitive effort.
This may be used in the real world for both positive and negative effects. Retailers may use it by setting an initially high price and then reducing it to the price they truly want so that it looks reasonable by comparison. In court, judges’ sentences may be influenced by the originally suggested sentence.
Awareness of the anchoring effect can encourage our attempt to mitigate it by thinking rationally regardless of our access to existing information. Belsky and Golivich’s (1999) book on behavioural economics agrees that before making money-related decisions, one should broaden their range of advisors and ensure they are able to see investments as worth more or less than what they originally thought. Similarly, people with more knowledge are proven to be less affected by the anchoring effect, whether it be due to pre-existing knowledge, or more extensive deliberation than average (Wilson et al. 1996).
The Ethical Implications of Choice Architecture:
Choice architecture has ethical implications due to its restrictive nature. Used intentionally, it is a tool of limiting the individual’s autonomy. Consumer willpower can be discouraged through priming and defaults, or by the use of anchors to boost prices, and these events happen without consumer awareness. In the case of anchoring, the bias is so psychologically rooted that even being told of its existence does not necessarily counteract its effect.
Therefore, it is of utmost importance that marketers do not take advantage of this. Although it is a general conception that businesses should be aware of their ethical responsibility toward maintaining consumer sovereignty, in the absence of economic incentive and a lack of conscience, policy intervention may be required to counteract this effect.
Conclusion:
In conclusion, behavioural economics illuminates the complex interplay between cognitive biases, human decision-making, and the structures that influence our choices. The default effect and the anchoring effect serve as potent reminders that our judgments are not immune to subtle influences. Recognizing and navigating these biases is essential for individuals and policymakers alike, as we strive to make informed decisions that align with our best interests and broader societal goals. The journey through behavioural economics is an invitation to understand ourselves better, to be vigilant against the pitfalls of irrationality, and to harness the insights gained for wiser decision-making.
Bibliography:
Belsky, G., & Gilovich, T. (2010). Why Smart People Make Big Money Mistakes and How to Correct Them: Lessons from the Life-Changing Science of Behavioural Economics. Simon and Schuster.
Critcher, C. R., & Gilovich, T. (2008). Incidental environmental anchors. Journal of Behavioural Decision Making, 21(3), 241-251.
Furnham, A., & Boo, H. C. (2011). A literature review of the anchoring effect. The Journal of Socio-Economics, 40(1), 35-42.
Molina-Pérez, A., Rodríguez-Arias, D., & Delgado, J. (2021). Opt-out policies capacity to increase organ donors is limited. medRxiv, 2021.08.27.21262033. doi:https://doi.org/10.1101/2021.08.27.21262033
Sunstein, C. R., & Reisch, L. A. (Eds.). (2017). The Economics of Nudge. Critical Concepts of Economics, vol. 4 Routledge.
Wilson, T. D., Houston, C. E., Etling, K. M., & Brekke, N. (1996). A new look at anchoring effects: basic anchoring and its antecedents. Journal of Experimental Psychology: General, 125(4), 387.
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