Explaining behavioural economics

Behavioural economics is different from economics. In this guide, we explain why, why it’s important, and why you should care.

Behavioural economics is the study of how economics impacts human behaviour. It therefore combines economics (the study of the consumption of goods and services) with behavioural science (the study of human behaviour).

This can be explained in greater detail by considering how specialists in each of these three areas typically operate.

• An economist will typically interpret data at a macro level to understand societal trends. For example, they may be interested in the relationship between inflation rate and consumer spending. This is the type of information that typically makes the news, and is used by financial institutions and investors. 

• A behavioural economist will typically interpret data by considering it in context with the principles of human behaviour. For example, using the example above, they may provide greater context to inflation rate by considering the impact inflation has on people’s perceptions. This is useful to marketers and investors to better understand how purchasing decisions are made.

• A behavioural scientist will typically investigate the biological and social principles that underpin human behaviour, such as conditioning and genetics. Although the term can often be used interchangeably with behavioural economist, a key distinction is their focus on exploratory rather than commercial research. This is therefore useful to academic institutions and the objective investigation of the principles that govern human behaviour.

There is a major difference between broad economic principles that explain how society operates and truly understanding why people make decisions. As a consequence, economists can easily make the mistake of interpreting how others behave by using their life view to fill in the gaps.

For example, economists typically refer to people as being rational and thereby capable of understanding the trade-offs and opportunity costs when making purchases. However, in reality, people rarely have the time or the information to be able to make cost/benefit decisions about the vast majority of purchases.

Furthermore, economists typically believe that people respond well to incentives, and particularly financial incentives that can be measured. However, although this is certainly true at a macro level, on a micro level, financial incentives are far from the only predictor of people’s behaviour.

For example, when selling a house, there typically isn’t a simple relationship between reducing the price and attracting buyers. To understand this requires a behavioural context. In doing so, it’s easy to realise that reducing a house’s price may create a perception that there is something wrong with it.

Economists hold many of the most significant and highly paid positions in society. However, as illustrated above, they typically simplify human behaviour down to broad economic rules.

Yet, because of their influence, we can all easily become conditioned to believe these rules to be true. After all, it’s natural for humans to want to control uncertainty, and economics is a perfect way to do it. Rules make it easier for financial forecasts to be created, and for plans to be drawn up.

However, this process can easily create a detachment between how people analyse the world and the reality. Behavioural economics therefore provides a more holistic view of people’s decisions.

Behavioural economics can be used to explain why emotional incentives and not financial incentives can be the driver of people’s decisions. This helps to explain a key paradox that faces every business.

All businesses are faced with the challenge of keeping their staff motivated to avoid them leaving. An economist’s perspective may be to suggest that employees are likely to stay for longer if they are given greater bonuses and higher pay. This can then be easily measured in financial reports to determine its success.

A behavioural economist will take a more nuanced view. Of course, they will acknowledge the power of financial incentives, but also investigate the importance of emotional incentives. They may therefore evaluate the performance of existing emotional incentives such as feedback, training, social interaction and recognition.

Data's explosion over the last decade has created a desire for businesses to de-risk their marketing activities by turning it into a science. This process has propelled many of the world’s leading companies.

This process has also transformed the way the marketing functions operate and their perception in most organisations. Marketers are now prized for their ability to assess and evaluate complex data sets, with data informing budgets allocations and measure return on investment in most instances.

Yet, this approach can only go so far because human behaviour is constantly evolving. This can become counterproductive for businesses that continue to make decisions based on what’s happened rather than what’s going to happen. In doing so, they can lack the creativity required to pursue marketing strategies that respond to future trends, as they can’t be easily validated with historic data.

Behavioural economics navigates the void between what has and what will happen. In doing so, it provides marketers with the necessary freedom to test new ideas. As a consequence, marketing activities become more inspiring for customers and more effective. This makes behavioural economics often crucial to the development of new companies or in changing the perception of industry incumbents.

Continue your interest

We hope you enjoyed this overview. Continue your interest in the topic by learning how to apply behavioural science to marketing. Alternatively, to discuss this with us, please arrange a call. We look forward to hearing from you.