Behavioral Economics got again a Nobel Prize

The Nobel Committee for Economics noted again representatives of the behavioural economics this year. This time, the prize was awarded to Richard H. Thaler for the studying of consumer behaviour and identifying the importance of psychological processes in the economy. But why is it so important? What were the conclusions of Thaler in the course of his studies? We will try to answer this question in this article.

In the last two decades, 4 of the 20 economic Nobel awards were given to behavioural economics specialists. This reflects the growing awareness among economists of the fact that people do not always act rationally, therefore theories of rational choice and effective market that have prevailed among economists for many decades need serious correction.There was a need to create a new science based on irrational decision-making approach. This is how the behavioural economy emerged.

Among the Nobel laureates, the supporters of this theory were G. Akerlof, M. Spence and J. Stiglitz (2001), D. Kahneman and V. Smith (2002), R. Aumann and T. Schelling(2005). This year, a reward of 9 million Swedish kroner(about $1.12 million) was given to Richard H. Thaler, a seventy-two-year-old professor. Thaler was an adviser to US President Barack Obama and also starred in the movie “The Big Short” about the mortgage crisis of 2007-2008. But people do not receive Nobel Prizes for their participation in the film, so we return to his contribution to the behavioural economy.

His hypothesis of economic decision making is based on psychological realism. He developed a new understanding of how human psychology influences decision-making. Richard himself has repeatedly stated that the main conclusion of all his studies is that “economic agents are people” and economic models should take this into account.

One of his main works in the area for which he received the Nobel Prize is the book “Nudge”. In this book, Richard describes a theory of “mental accounts”. The essence of this theory is that people in decision-making create in their minds a few separate accounts and focus on more particular consequences, rather than on the cumulative effect. His research on the notion of “fairness,” which showed how consumer anxiety can cause companies to refrain from rising prices during periods of high demand, but not during rising costs, had a significant impact on economic science. Companies have learned how to earn on the irrationality of consumers a long time ago. The same bottle of mineral water in a hotel is worth more than in a beach café because it corresponds to the people’s view of fair pricing. And many buyers prefer discounts to constant low prices because buying with discount satisfies the underlying human senses the desire to buy goods cheaper.

Thaler showed how people amenable to short-term temptations, that explains the inability of many to engage in financial planning and retirement saving.

He also believes: investor behaviour is determined by the minor factors associated with emotions and mood much more often than it would admit. For example, the willingness to take risks may be affected by the way in which the investment is described, hungry or fed was the investor at the time of the decision, what weather on the street, his favourite team last results. All these factors can influence the decision-making, even if the person does not realize this.

Based on his findings, he proposed a strategy for “libertarian paternalism.” It is aimed at pushing people to the optimal choice dictated by reason, rather than feelings or short-term temptations. He described his theory in detail in the book “Nudge”. This theory will especially be to the taste of traders, for whom it has been important to achieve an emotionless state for many years.

Thus, Richard not only opened the eyes of the public to the psychological basis of most decisions but also explained how to influence it. To understand what drives you, to turn that feeling off, to act rationally against your own desires  – here’s a recipe for success. If we all adhere to these rules, improve our micro-economy, the macroeconomic indicators will also grow. A prosperous and abundant world awaits us – the dream of any resident of the planet. Definitely, such work is worth the Nobel Prize.