Behavioural Economics and Our Work
Last month, the Swedish Royal Academy of Sciences announced that this year’s Prize in Economic Sciences in memory of Alfred Nobel was awarded to Richard Thaler for his contribution to behavioural economics over four decades. We congratulate Professor Thaler for his outstanding contributions to the field, one which provides critical insights for energy and environmental policy.
Many economic theories assume that the decisions that we all make are perfectly rational, we are homo economicus. But in reality, humans are a lot more complicated, and behavioural economics has provided a framework which can help explain the way we make decisions and deviate from expected behaviours. Of course, advertisers and marketers have been making use of these cognitive quirks for a long time without the framework provided by behavioural economics. But policymakers should also be aware of, and utilise these deviations in the design of effective policies. The growing recognition of behavioural economics as critical consideration has resulted in 51 countries with state-led behavioural policies (Whitehead et al, 2014).
Within behavioural economics, there are three main categories of behavioural biases: bounded rationality, bounded willpower, and bounded self-interest. Bounded rationality recognises that our brains are not perfect computers and that our decisions are affected by the limited information at our disposal, our brain’s cognitive limits, and the limited time in which we must make decisions. Bounded willpower concedes that we often make decisions that are inconsistent with our long-run interests, while bounded self-interest recognises that some decisions we make are to the benefit of others and not ourselves. Many important behavioural economics concepts emerge from these categories. We cover a selection of the key concepts below for designing environmental, energy and transport policies.
Loss aversion tells us that we dislike losing something from our possession more than we like acquiring the equivalent amount. For example, a five-cent tax on disposable shopping bags in Washington DC reduced use by a substantial amount, while a five-cent bonus for using a reusable bag had essentially no effect on behaviour (Homonoff, 2015). That’s because the tax was a loss for consumers, which had more impact than the equivalent bonus. Policies to induce behavioural shift need to be framed in a certain way so that consumers respond optimally.
Status quo bias occurs when we tend to pick the default option or make the choice we’re used to making, not because that option is necessarily better but because there is a fear of change. This bias can make it difficult for policymakers to encourage consumers to change their behaviour towards taking public transport more often or recycling more. But closely related is default bias, where we as decision makers go with the flow, and would rather not make a taxing decision if we don’t have to. This can be utilised by policy makers to set the pro-environmental action as a default.
Social norms dictate what choices we may find appealing. This is also known as herd behaviour or “jumping on the bandwagon.” What others decide to do may be a bigger effect on your decision-making than the traditional cold calculus we assume rational humans make. For example, if all your friends wore bike helmets when cycling, you might be much more likely to do so. Or, if you are told you are using more energy or resources than your neighbours, you are likely to reduce your consumption to meet the norm.
At Ricardo Energy & Environment, we recognise how important these behavioural biases are for our work for governments, international bodies, associations and industry groups, and private companies. Well-designed policy behavioural approaches can help our clients:
Our behavioural economics toolkit is multi-faceted. We can incorporate these behavioural biases in our models of energy and emissions to better predict behavioural response. We can build complex consumer choice models that allows for these behavioural biases to change the predicted choices consumers make and in this way, building something that mirrors reality more closely. Similarly, we can take these biases into account in our cost-benefit models to support policy or investment decisions. We can design labels for consumer appliances and vehicles that nudge people to choose the most energy efficient and environmentally-sound options. Where we need to investigate how behavioural biases will affect choices, we can design randomised controlled trials (RCTs) to test behaviour in a rigorous way.
To discuss any of the topics raised in this blog, or to find out more about Ricardo's work supporting effective policy development at local, regional and national levels, email Kareen.ElBeyrouty@ricardo.com
Homonoff, T. 2015. “Can Small Incentives Have Large Effects? The Impact of Taxes versus Bonuses on Disposable Bag Use.”
Thaler, R.H. and C.R. Sunstein. 2008. Nudge: Improving Decisions about Health, Wealth, and Happiness. New Haven: Yale University Press.
Royal Swedish Academy of Sciences, Committee for the Prize in Economic Sciences in Memory of Alfred Nobel, “Scientific Background on the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2017.” 9 October 2017.
Whitehead, M., R. Jones, R. Howell, R. Lilley, and J. Pykett. 2014. Nudging All Over the World: Assessing the Global Impact of the Behavioral Sciences on Public Policy. Economic and Social Research Council, UK.