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DELUSION OF DECISIONS - The Rise of Behavioral Economics 09.09.2022

Where did this "behavioural economics" come from?

When we look at classical economic theories, we see that the majority of the theories developed accept that stakeholders make their choices according to optimum gains. According to these theories, it is accepted that people, firms or countries will choose the best among their choices when making their choices, that they will act only in their own interests and completely ignore the interests of other stakeholders, that there are perfect market conditions, that habits or prejudices will not affect the decisions taken in the economic framework, for example, a simple purchase decision.

According to the dictionary, economy is briefly defined as the branch of science that examines the ways in which people produce and divide what they produce in order to live and all the relations arising from these actions.

If we take into account the fact that even the dictionary definition mentions human relations, we are faced with the fact that the theories and theories of economics cannot be considered independently of the factors that affect human behaviour, for example prejudices or dependencies, or emotions.

Some people are smarter than others, not all people can be expected to react in the same way to the same situation, some firms are better managed than others, the example of addiction shows that people do not always try to maximise their gains or shares, for example, you cannot explain the behaviour of someone who gives up his fortune at the gambling table by numbers alone.

All of the assumptions and assumptions of economics have been accepted as valid for the type of person accepted by the science of economics, which is called homo economicus.

However, such an approach, which tries to be explained with algorithms, standard deviations or formulas etc. used by classical economics, is weak in explaining market bubbles, excessive credit card spending, luxury consumption or unconscious loans.

At this point, "Behavioural Economics", which we can call a new branch of science or discipline, comes into play.

Behavioural economics, which is complementary to classical economics rather than a challenge to it, argues that the rationality or rationality in decision-making mechanisms assumed by classical economics cannot be valid in all cases and that human behaviour and the (non-rational) factors affecting these behaviours (which are mostly within the scope of psychology) should also be taken into consideration in order to examine decision-making mechanisms.

Behavioural economics is a discipline that can help us understand judgement and decision-making mechanisms that economic theories alone cannot explain, and help us to create the necessary infrastructure for people to make more effective decisions.

Although its foundations are thought to have been laid by Amos Tversky and Daniel Kahneman in the last thirty years, the need for behavioural economics has been accepted by economists for a long time.

In 1906, Italian economist and sociologist Vilfredo Pareto argued that classical economics and other social sciences should be analysed through the principles of psychology [1], and in 1918, American economist John Maurice Clark stated that ignoring psychology meant ignoring human nature. [2]

In his 1776 work "The Wealth of Nations", the philosopher Adam Smith, who is considered to have laid the foundations of classical economics and liberal economics, wrote his first lesser-known work "The Theory of Moral Sentiments" in 1759. He argued that decision-making is largely influenced by emotions, which he described as "passions", and that decision-making emerges as a result of the conflict between these "passions" and the "impartial spectator" who scrutinises each decision in detail. [4]

In 1979, Tversky and Kahneman, with their experimental studies, argued that the human nature approach accepted by classical economic theories was insufficient and that decisions were not always optimal. Kahneman was awarded the Nobel Prize in Economics in 2002 for his contributions to the rational economic theories of psychology.

One of the most important examples of stakeholders not behaving rationally is the so-called "ultimatum game".

In this game, which is played with two parties, the bidder and the offer evaluator, a sum of TL 1,000 is put in the middle, and the bidder must offer the other party a percentage to be determined by himself over this sum. For example, 20%-80%, 10%-90% or 50%-50%. The person evaluating the offer either accepts or rejects the offer. In the case where the bidder's offer is rejected, both parties will return empty-handed without any gain.

Studies show that as a result of the "Ultimatum Game", the parties often return empty-handed. When considered logically or rationally, the evaluating party should accept even a 5% offer. At the end of the day, the 50 TL in the pocket of the party evaluating the offer will be greater than zero.

However, at this point, it becomes clear that the mechanisms we operate while making decisions are not always rational, on the contrary, our emotions and subconscious mind (primitive brain) are activated while making most decisions. Therefore, human beings are far, far away from acting in a completely rational and profit-maximising manner as accepted by classical economics.

Thaler argues that the human being assumed in economic theories, in other words, the human being modelled within the framework of economic science, homo economicus (econs) as he calls it, is assumed to have mathematical knowledge at the level of a mathematics professor or self-control at the level of Gandhi, but the real human being has very different decision-making mechanisms than these assumptions. [4]

Perhaps the most important thing that behavioural economics teaches us is that people are prone to making bad decisions.

Behavioural Economics and Marketing

Psychological approaches to people's decision-making mechanisms are of much greater importance for marketing science. As a result, marketing emerges as a discipline that can be summarised as the art of directing or changing people's consumption habits.

Marketing studies to be conducted with behavioural economics are of great importance in terms of directing people's perceptions about products or services.

100 is greater than 100

Number of standing passengers (inaccuracy of figures)

Rory Sutherland, Chairman of Ogilvy, a British marketing and advertising company, argues that the behavioural economics approach opens new horizons for marketing science and underlines the importance of evaluating the demand for any product or service within the framework of psychological science.

Sutherland gives an example of railway companies as an example of the consequences of making decisions based only on numbers and ignoring other factors that may affect human attitudes and behaviour.

Sutherland underlines that when calculating the number of monthly standing passengers and its effect on customer satisfaction, not only the number of standing passengers but also the qualities of the standing passenger and the effect of his/her experience on his/her mind should be taken into consideration, and while evaluating a situation where the number of monthly standing passengers is one hundred people, he states that the situation where 10 people stand 10 times and 5 people have to travel standing 20 times is very different in terms of customer perception and expresses the metaphor of 100 > 100.

According to Sutherland, "Perception is relative, if you can change the perception, you can change the emotional reaction and consequently the behaviour without changing the object, and you can create the perception that something very bright is something terrible and something very terrible is something bright, depending on the way anything is presented."

Behavioural economics opens new windows on people's buying behaviour, brand perception and marketing that will contribute to classical economic theories and marketing approaches.




[1] “The foundation of political economy and in general of every social science is evidently psychology a day may come when we shall be able to decide the laws of social science derive the laws of social science from the principles of psychology”, Vilfredo Pareto (1906)

[2] The economist may attempt to ignore psychology but it is sheer imposibility for him to ignore human nature.  Journal of Political Economy 1918, Prof. John Maurice Clark

[3] Richard Thaler, Prof: "Misbehaving: The Making of Behavioral Economics" | Talks at Google, 4 haizran 2015

[4] Richard Thaler, prof, Richard H. Thaler – Cass R. Sunstein: Nudge: Improving Decisions about Health, Wealth, and Happiness

[5] Adam Smith, The Theory of Moral Sentiments, 1959

[5] Behavioral Economics: Past, Present and Future, Richard H. Thaler, University of Chicago, 2018 Ryerson Lecture

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