Notes on Behavioural Economics

Important keypoints from EDX Behavioural Economics course (BE101x) from University of Toronto.

Rational Choice

The 4 C's of Rationality

In order to be perfectly rational, people should have:

  1. Complete information.
Complete information about outcomes and it's probability, future events, observable and unobservable attributes, and relevant contextual factors needed to interpret and evaluate these data.
  1. Cognition and not emotion driving decision making.
Emotions like regret, potential regret, guilt, sympathy etc could effect decision making.
  1. Computational ability.
The ability to calculate the utility of options on the fly, which requires the brain to perform tasks such transforming, multiplying, discounting, adding etc. When computation is contrained (which is always the case with humans anyway), their rationality are termed as "bounded rationality"
  1. Consistency with the axioms of choice.
The axioms of choice: 
	a. Completeness and continuity
		i. Completeness: For all X and Y, we have X ³ Y, or X £ Y, or indifference
		ii. Continuity:There exists some probability such that a gamble between the best and the worst outcome is as attractive as receiving a sure intermediate outcome.
	b. Transitivity
		For example, if a person prefers A over B, and B over C - then the person must prefer A over C.
	c. Substitution

Based on the above, we can see that humans rarely have the above traits and thus - most of the decisions being made can be considered - irrational.

Decision Points

In short, a decision point is any intervention that is designed to get an individual to ‘pause and think’ about the consumption they are currently engaged in. There are a number of ways in which decision points can be created, but there are three broad methods:

  1. Inserting transaction costs

which work on the premise that requiring the individual to take a positive action makes them deliberate on the consumption decision

  1. Providing reminders or information

which work on the premise that drawing attention to a neglected activity can provide the impetus to get it done with

  1. Creating interruptions to the consumption activity

which work on the premise that the interruption allows the individual to pause and think

In many cases, these three basic methods can be combined to create powerful interventions of decision points.

More details here: https://piedpi.slack.com/files/ikanez/F0DSWAQN8/BE101x__Decision_Points

More reading here:

http://www-2.rotman.utoronto.ca/rotmanmag/Soman.pdf

Mental Accounting

Loss Aversion

Definition: People value losses 2 times more than gain. As such, people are less likely to take risk when they might lose something rather than gain something of equal amount

Example:

Sunk Cost Effect

Definition: 

Example:

Decoupling

Definition: Reduction in the strength of association between cost and benefit.

Example:

Choice Overload

  1. We need to simplify decision making so that consumers are not overloaded with choices and ending up choosing other brands.

Self Control

Hyperbolic discounting

Spending Uncash

  1. Payment mechanism matter
  2. As payment change from cash > credit card > autopay, the transparency of the transaction becomes less salient.
  3. This makes metering, or keeping track of ones expenditure hard.
  4. Research shows that people who routinely use credit card spend more.

  • Takeaway: If you want people to spend more, make the transaction process less transparent.