Comparison between Behavioural Economics and Standard Economic Model - Example

The Concept of Choice Architecture and the ‘Save More Tomorrow’ Schemes Relating To Behavioral Economics Table of Contents Table of Contents 2 Introduction 3 Comparison between Behavioural Economics and Standard Economic Model 4 Critical Examination of the Behavioural Economic Model 6 Policy Implications of the Behavioural Economic Model In Contrast To the Standard Economic Model 7 Conclusion 9 References 11 Introduction The concept of choice architecture and “Save More Tomorrow” can be described on the basis of behavioural economic theory and standard economic theory. Behavioural economics may be referred to an admixture of economics and psychology. Thus, behavioural economics deal with the creation of market decisions as well as the factors affecting the choice of the people. In behavioural economics, the assumptions that are made about people are essential to be supported with realistic assumptions. However, the concept of behavioural economics was invented by Adam Smith in order to draw accurate conclusions in the economic decision making process (Social Science Electronic Publishing Inc, 2014). On the other hand, the standard economic theory is also known by the name of expected utility theory. It may be defined as the characteristics of a person to maximise the utility of the goods and/or services consumed by him/her. However, the basic principle of this theory is based on the fact that consumption made by the people is deemed as essential to them (Thaler & Benartz, 2004). The standard economic theory is also based on the assumptions that human beings are rational, being always focused on the maximisation of their personal interests. In order to construct a critical economic analysis, theorists have often intended to merge the behavioural economic theory with the standard economic theory (John Wiley & Sons. Inc, 2014). In the discussion henceforth, emphasises towards relating the two major economic theories of the contemporary era, with respect to the thought of ‘Save More Tomorrow’ as adopted by the US and the UK. Comparison between Behavioural Economics and Standard Economic Model The concept of behavioural economics is primarily based on the study of human psychology with its focus on finding out the influence of the behaviour of people on their purchasing decisions and therefore, also signifies their intentions of saving. Behavioural economics not only explains the rational behaviour of the human beings but also focuses on their psychological aspects, which are considered as a major benefit of this economic model. It is considered as an integration of economics and psychology that helps in investigating the market situation, which is being affected by the behaviour of the human being, indicating their choice architecture. Thus, it can be observed that the principles of behavioural economics focus on the influence of the human behaviour in the economic decision-making, which can also be used to interpret their saving attitudes. It is noteworthy in this context that most of the economists prefer behavioural economics rather than the standard economics for carrying out the analysis, as behavioural economics provide the results in a more realistic manner. The concept of behavioural economics is based on three principles, involving the thumb rule principle, framing problems and market efficiencies. Observably, people behave according to the thumb rule rather than the rational thoughts, i.e. they believe in the principle that they are consuming goods according to the amount they are paying (Camerer & Loewenstein, 2002). However, a product with cheaper price may be as good as the expensive ones, irrespective of which, consumers commonly distinguish the product as of inferior quality and purchase the products of higher prices. Framing problem is the second concept of behavioural economics. When a problem is faced by the people, their thought process is affected through the presentation of the problem, which further reflects their unique choice architecture. However, if a company makes advertisement of its products in different ways, consumers are also quite likely to act differently. For example, when a company provides discount of 80% on a particular product, consumers become more interested towards the offer, rather than the company providing a discount of five dollar, whereby the people lack sufficient understanding about the original price of the products, hampering their attitude towards savings. Thus, proper presentation of advertisement can affect the psychology of the people on the basis of which they decide their purchases. Market inefficiency is the third concept of the behavioural economics. Market efficiency may be defined as the situation where the investors have a clear idea of the stock by looking at its price. On the contrary, market inefficiency is the situation where consumers do not possess adequate knowledge regarding the prices of the stocks, which may lead to the selling of overvalued stocks and purchasing of undervalued stocks by the investors (Camerer & Loewenstein, 2002). In contrast, standard economics mainly focus on the maximisation of utility that is derived from the consumption of goods and/or services and is based on the consumption pattern followed by consumers and hence, can be better related to the savings attitude of consumers. Standard economics is based on mathematical and statistical calculations. Many economists are of the opinion that this economic model is more relevant than the behavioural model. However, a critical review of the principles adopted by these two models indicates that there are certain unrealistic traits included in the standard economic model, such as unbound willpower, unbound rationality and unbound selfishness. However, all of these traits are modified in the behavioural economic model (Thaler & Benartz, 2004). Critical Examination of the Behavioural Economic Model To be noted in this context, the idea of ‘Save More Tomorrow’ adopted in the economic models of the US and the UK emphasises the requirement of savings for individuals owing to several reasons ranging from uncertainty in traditional economic processes as well as growing inadaptability of the behavioural theory in the modern era, depending on the persistent choice architecture amid consumers. As argued by Hardcastle (2012), behavioural economic model is quite likely to have both positive and negative effects on the savings attitude of consumers, but mostly indicate uncertainty owing to the widening gap between the current day context and the traditional principles, which the theory inculcates. Contextually, the criticism of behavioural economics is mainly focused on the rationality of the economic agents as was addressed by Diamond (2007). Similarly, according to Herbert Simon, the fact that the people have unlimited access to information is irrelevant, which in turn justifies the argument that behavioural theory is becoming increasingly unviable to suffice modern day demands (The Slate Group LLC, 2014). According to Diamond (2007), the cognitive theories of the behavioural economics are regarded only as the models of decision-making, rather than generalized economic behaviour. They are only applicable to solve the decision problems that are presented for assessing the survey respondents, which again indicate towards a limitation of the stated model. The traditional economists are also against the survey based techniques and experimental techniques that are used largely in behavioural economics. However, as argued by Thaler & Benartz (2004), many economists have also dismissed the criticisms and are of the opinion that a uniform result can be obtained depending upon the situation that can in turn produce a good theoretical awareness. Hence, it can be argued that behavioural economists are of the opinion that focusing on the field experiments, instead of the lab experiments may yield better reliable results, while in the reality, the uncertainty persisting in the economic performances of the market tends to depict a scenario almost contrasting (Hardcastle, 2012). Undoubtedly, there is a vast difference persistent between behavioural economics and experimental economics, especially when considered in reference to the idea of ‘Save More Tomorrow’ with respect to the implications of the stated theorems. However, as argued by Byrne (2004), as the principles of behavioural economics deal with the decision making of the people rather than the decisions as stated by the classical economists, it becomes comparatively more realistic that can help consumers make decisions for savings rather than on larger consumptions based on their choice architecture (Thaler & Benartz, 2004). Policy Implications of the Behavioural Economic Model In Contrast To the Standard Economic Model Stating theoretically, principles of behavioural economics are an extension of the standard economics framework mainly based upon the concept of sociology and psychology. Behavioural economics has its applications in various fields but is criticised to be lacking in the domain of economic techniques, such as the ‘Save More Tomorrow’ strategy adopted by the US and the UK. To be mentioned in this context, in this particular domain the application of the behavioural economic model has been much apparent being used in understanding the financial markets and the market situation. It also acts as an important model of consumer decision making, which in turn tends to determine the savings pattern within the economy (Harvard Magazine Inc, 2014). Apart from financial sectors, behavioural economics also play an important role in analysing the cost of a product in the market, which is beneficial for both buyers in making purchasing decisions to signify their choice architecture. Behavioural economics also play an important role in the field of macroeconomics and thereby, have been used to determine savings patterns within the economy. However, in contrast to the standard economic policy, there are various concepts in macroeconomics that are based on psychology rather than on statistical conclusions (Harvard Magazine Inc, 2014). The life-cycle model of savings is regarded as an important facet therewith. This theory illustrates that people make assumptions of their lifetime earnings and on the basis of their estimations at the onset, based on which they decide the amount of money to save and consume in order to lead their life smoothly. In contrast to the standard economic theory, behavioural economics also play an important role in the understanding the wages problem related with the labours with minim complexities. It is thus assumed that unemployment occurs due to excess wage distribution to the labourers. For instance, if the wages are paid above the normal wage rate, there will be more availability of labours, which will lead to unemployment owing to a definite amount of employment capacity (Forbes.Com, 2014). It is in this context that “efficiency wage theory” describes why the workers are paid more being a dimension of behavioural economics, which further indicates towards the significance of savings among the consumers of an economy based on their choice architecture. It is owing to this reason that the workers are paid more wages and thereafter, ensure that if they are being retrenched from the organisation, they will lose a handful of wage, and with the fear of getting retrenched, the workers will work more sincerely and effectively as well as save more (The Slate Group LLC, 2014). Thus, paying more wages acts as a motivating factor and behavioural economics plays an important role in understanding the labour psychology and the market environment in contrast to the quantitative methods followed in standard economics. Similarly, the standard economic model also has its implications in various fields. However, the standard economic model mainly focuses on maximising the utility function of an individual. This economic model has a significant influence in policymaking decisions, as it tends to enhance criticality as well as reliability of the information gathered (Mises Institute, 2014). Conclusion Conclusively, it can be stated that in order to describe the concept of choice architecture and ‘Save more Tomorrow’ it is essential to obtain a detailed analysis of the behavioural economics as well as the standard economics, as both these frameworks have strong implications on the notions stated. Theoretically noting, behavioural economics is focused mainly on the psychology of the human beings in order to understand their behaviour in decision-making. However, it is a combination of the psychology and economics implemented in order to understand the influence of human behaviour on the market and the economy that also includes the notions of choice architecture and ‘Save More Tomorrow’. Whereas, the standard economic model focuses mainly on the individual’s self-interest in maximising the utility that he/she gets by consuming a particular product or service. The comparison conducted above however revealed that behavioural economics is more realistic than the standard economic model, as the surveys and experiments that are carried out are based on the real life situations often obstructed by the assumptions and knowledge base of the researchers. This economic model also plays an important role in the financial sectors for making various financial decisions as well as for deciding a proper wage rate for the workers. References Byrne, A., 2004. Employee Saving and Investment Decisions in Defined Contribution Pension Plans: Survey Evidence from the UK. Discussion Paper PI-0412. Camerer, C.F. & Loewenstein, G., 2002. Behavioral Economics: Past, Present, Future. Journal, pp. 1-61. Diamond, P., 2007. Behavioral Economics. Journal, pp. 1-10. Forbes.Com, 2014. The Business of Behavioural Economics. Leadership. [Online] Available at: http://www.forbes.com/sites/hbsworkingknowledge/2014/08/11/the-business-of-behavioral-economics/ [Accessed December 11, 2014]. Hardcastle, R., 2012. How Can We Incentivise Pension Saving? A Behavioural Perspective. Working Paper no 109. Harvard Magazine Inc, 2014. The Marketplace of Perceptions. Cover Article. [Online] Available at: http://harvardmagazine.com/2006/03/the-marketplace-of-perce.html [Accessed December 11, 2014]. John Wiley & Sons, Inc, 2014. Behavioral Economics vs. Conventional Economics. Technical Analysis. [Online] Available at: http://www.dummies.com/how-to/content/behavioral-economics-vs-conventional-economics.html [Accessed December 11, 2014]. Mises Institute, 2014. Behavioural Economics and Irrational Voters. Mises Daily. [Online] Available at: http://mises.org/library/behavioral-economics-and-irrational-voters [Accessed December 11, 2014]. Social Science Electronic Publishing Inc, 2014. Choice & Architecture. Journal. [Online] Available at: https://www.sas.upenn.edu/~baron/475/choice.architecture.pdf [Accessed December 11, 2014]. Thaler, R.H. & Benartz, S., 2004. Save More Tomorrow: Using Behavioral Economics to Increase Employee Saving. Journal of Political Economy, Vol. 112, No. 1, pp. 64-87. The Market Research Society, 2014. Viewpoint: Why Behavioural Economics Should Only Make Market Research Stronger. Article. [Online] Available at: https://www.mrs.org.uk/ijmr_article/article/93708 [Accessed December 11, 2014]. The Slate Group LLC, 2014. Behavioral Economics under Attack. Why We Do What We Do. [Online] Available at: http://www.slate.com/articles/life/ft/2011/01/why_we_do_what_we_do.html [Accessed December 11, 2014]. Read More