This article was updated on August 7, 2018.
Supply. Demand. Utility. If you ever slept through an economics class in college, you probably heard your classmates throwing these terms around as you walked back to the dorm. They're like the first three tracks on Classical Economics Greatest Hits, Vol. 1.
What Is "Behavioral Economics?"
But terminology aside, here's what you may have missed. Economics is ultimately about making predictions. Economists build models to forecast how human beings behave in different situations. These models often (but not always) focus on the distribution and consumption of resources.
Hey — stop nodding off. It gets better.
When you dig a little deeper, you learn that with every economic model comes a pretty long list of fairly significant assumptions. I could write more about the complexity of assumptions in modeling, but I'm afraid that might put me to sleep.
Rather, let's focus on one common economic model assumption in particular: that human beings are perfectly rational. I know. That's hilarious.
Of course, "rational" in this context might mean something different than how it is used in arguments between significant others, so let's first agree on a shared definition. For our purposes, "rational" means perfectly logical. It describes decision-making as a consideration of all possible variables with perfect weighting, resulting in a clear choice driven by self-interest.
Perfectly rational thinking is free from emotion and bias, never tired nor frustrated. It treats the prospects of tomorrow, next week and next year with balanced proportionality. It is neither risk seeking nor risk-averse. It makes the best decisions based on the available information every time. In other words, rational thinking is pretty much the exact opposite of what actual people do. (Not you, of course!)
Yet the assertion that human beings tend to think "irrationally" is no slight to the human condition. As Albert Einstein (allegedly) said, "If you judge a fish by its ability to climb a tree, it will live its whole life believing that it is stupid." In other words, don't judge a car because it can't fly. It wasn't built to.
The human mind is simply not designed to process the amount of information that is consciously available to it. Even if it could, it would still be subject to powerful emotional influences, distorting perceptions to serve unconscious motivations.
To survive, we've had to rely on coping mechanisms in the form of mental shortcuts, often referred to as "heuristics" and/or "biases." (Fittingly, most people have developed a bias against the term "bias," but that's a conversation for another day.) From an evolutionary perspective, heuristics and biases are sufficiently effective for us to thrive. After all, we're still here.
Yet there's a downside, which brings us full circle. An inevitable outcome of relying on heuristics and biases, and therefore an inevitable outcome of human existence, is irrationality. We are all inevitably prone to it, with consequences ranging from trivial to life altering. Though it may be easier to discern why this matters for individuals, it is perhaps even more significant for organizations.
While the breadth of activities and initiatives undertaken by organizations is too massive to cover, there is a common thread in much of what they do: influence. Whether customers, constituents, employees, analysts or stakeholders, organizations are usually trying to persuade people toward thoughts, feelings or actions. They do this through communications and design, whether of products, processes, programs, policies or even alliteration.
This raises a fundamental question: for who are these communications and designs created? With great frequency, the answer is, "Rational people." And that, my friends, is why so much stuff doesn't work.
But all is not lost. Irrationality is not random. It's a language we can learn. And when we speak it, we are much more effective, in every way.
Why We Should Care About Behavioral Economics
So what is behavioral economics? It's that language. Behavioral economics is the study and forecasting of how people actually think and behave, rather than how they "should," at least according to logic.
And why should we care? Because it is only by incorporating behavioral economics into our communications and design that we can expect to serve our actual intentions. Anything else would be, dare I say, irrational.
And that's what The Applied Guide is all about. Each month, I will introduce one major behavioral economics principle. I'll describe what it is and how we can apply it to achieve your organizational objectives.
But don't fret! You won't have to wait a whole month for my next post. Because even though I have reached the end of our collective short-term attention span, there is still much to cover, including specific and relevant examples to whet your appetite for more. That's right — Part 2 is available right here for you.
Other articles in this series:
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