Traditionally, economics has been divided between two core areas: macroeconomics for analysing economic aggregates (i.e. GDP, inflation, unemployment), while microeconomics focuses on the decision-making processes of economic agents (i.e. producers, consumers). It is the latter in which economists like Kahneman and Vernon Smith – who shared the prize in 2002 – have found psychology to be a great ally, by embedding insights from cognitive psychology within their economic analysis.

Human beings were not behaving in an economic environment as these theories predicted, because we are not rational

A key similarity between both sciences is that they analyse human decision-making. Kahneman was awarded the prize for his research in this area, especially for his research into situations under uncertainty, while Smith established lab experiments as a fundamental empirical tool in the behavioural economics toolbox.

Thanks to research kick-started by behavioural economists, we now know the neoclassical theories behind many economic predictions were flawed. Human beings were not behaving in an economic environment as these theories predicted, because we are not rational.

We are generally prone to partial rationality or, as coined in mainstream literature, bounded rationality. If this was not enough, we tend to resort to our intuition, beliefs, judgements, and own perceptions of the world we live in. All things considered, we are not theory-driven decision-making machines that react with infinite accuracy to the expected. Despite being portrayed as the ‘homo oeconomicus’ in economics 101, we should actually focus on the ‘homo irrationalis’, the irrational person.

So how is the growing area of behavioural economics being put into practice? In 2010, the British Government set up a special unit named ‘Behavioural Insights Team’ (BIT). In practitioner circles it started to be named as ‘The Nudge Unit’; inspired by economist Richard Thaler’s book Nudge: Improving Decisions About Health, Wealth, and Happiness. Thaler used the term ‘nudging’ to describe how interventions in decision-making can be used to encourage desired behaviours. BIT’s aim was to explore nudging as a means of policy-making, in areas as broad as health, personal finance, or organ donation.

The Unit has been successful, as shown by reports published during the last five years. Achievements include helping Essex county council job advisors develop better back to work programmes by designing routines and specific commitments that jobseekers had to complete during their job search activity (‘implementation intention’); analysing e-cigarettes as a potential tobacco deterrent (it’s easier to substitute a behaviour than to eliminate an ingrained one); and increasing the organ donor pool by testing different messages to encourage donors to register (message testing).

From a business perspective, we should focus on how nudging can be used to improve our results, or how our competitors may use cognitive biases to increase their market share. For instance, a good salesperson should know that the first rule of sales is fulfilling the client’s needs. The trick lies in showing potential customers that you are acknowledging their views -what he/she needs, when, and how to communicate with them. Being aware of their customers’ cognitive biases, like present bias (overvaluing present rewards against future ones), projection bias (underestimating possible future changes to own circumstances), loss aversion (tendency to feel losses more than gains), or social influences, can help salespeople tweak their product portfolio, sales channels and workflow.

A word of caution though, on the consumer side the Competition and Markets Authority (CMA), the Financial Conduct Authority (FCA), and the Office of Fair Trading (OFT) have already been scrutinising some of these practices. For example, payday lenders were making profit on the fact that borrowers suffered from present bias, utilities companies have taken advantage of consumer inertia not to switch providers and consumer electronics companies have offered discounts so large that they discourage price comparison. Counter-measures are being taken to protect the consumer’s from these influences. So be aware, nudge with moderation.

Francisco Marco-Serrano is a senior lecturer in economics, GSM London

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