Behavioral Economics - Concepts
Although most behavioral economics concepts revolve around the irrational decisions people make, concepts like heuristics, choice overload, and mental accounting are somewhat positive, in that they can be adopted by people who want to save money
- Also known as "rule of thumb" heuristics are mental shortcuts that help simplify the decisions people make, especially during situations of uncertainty.
- Heuristics is a process of "substituting a difficult question with an easier one." Although it is said to lead to cognitive biases, there are several advantages of heuristics.
- The fast and frugal school of thought claims that applying heuristics in an ecologically rational condition leverages the best use of the limited options available to people.
- Heuristics/rule-of-thumb strategies such as committing to not spending over $20 on a dress or $100 on something that is not a need help simplify daily choices.
- According to Forbes, positive heuristics can be powerful enough to override bad money behavior. Other examples of heuristics strategies that work include deciding to always take tax returns to the bank or deciding to only buy used cars.
- Behavioral economists have also asserted that developing positive heuristics can help people adopt good money habits.
- This concept asserts that when individuals are presented with too many options, they become overwhelmed and develop decision-making paralysis. Eventually, the individuals opts out of buying that product.
- While this is sometimes seen as a negative thing, it stops people from making irrational purchase decisions.
- To persuade consumers, sometimes retailers and marketers may present them with too many choices.
- Ultimately, decision-making paralysis could stop people from buying products that they want but do not need.
- Richard Thaler, also known as the father of economics, observed that people treat different sources of money that are earmarked for distinct uses, differently.
- The money-saving bias associated with this concept is that physical cash is worth more than payments made online or digitally.
- Humans supposedly feel more pain paying with a wad of cash, while a frictionless one-click payment on Amazon is practically guilt-free, in comparison.
- As a result, most individuals that want to spend less use only cash. This is also a tip for saving money that experts like Ramit Sethi - NYT best-selling author - recommend.