Behavioural economics is a branch of economics that seeks to understand the motivations and reasons behind individual decisions.
Rational choice
In traditional economics, there is a very basic assumption that individuals are rational utility maximisers. i.e. firms seek to maximise profits; workers seek to maximise income and levels of consumption. (see – rational economic man)
Therefore many economic models are based on the idea that people will choose the action/good which maximises their utility. (welfare)
However, this branch of economics leaves little room for irrational decision-making. This can include decisions based on fear or decisions based on altruism.
However, other models of rational choice models seek to incorporate non-monetary utility into models. For example, if people gain happiness from giving to charity – then it is perfectly rational to give rather than buy a car which may give less utility.
Economics and charity
Assuming rational self-interest, it is hard to understand why somebody would make a large anonymous donation to a charity. It could be explained by the utility (satisfaction) someone may feel from consuming the good feeling that giving to charity gives. Nevertheless, it makes it harder to base economics solely on a monetary self-interest basis.
Economics and genuine altruism
Some charitable giving can be explained by the utility the gift-giver gets. However, individuals could still act out of genuine altruism where their abiding motivation is not their personal utility but wider concepts of what is ‘the right thing to do.’ For example, the anonymous charity giver whose primary motivation is to help those less-fortunate – even if they never receive any recognition for their effort.
Altruism and firms
Similarly, we can see many examples of altruism within firms. For example, some firms will employ workers, even if they are not necessary. This is because they don’t want to create unemployment. Also, firms may not seek to maximise profits. Firms may have many other objectives such as environmental objectives, charitable objectives and social responsibility. At one level environmental concerns can be a clever marketing ploy, but, at another level, they can be made independently of financial considerations.
Psychology
Behavioural economics takes elements of psychology to explain economic decision making. One issue which keeps occurring in economics is irrational booms and busts. People often get caught up in ‘bubbles’ where the value of assets increases above their long-term value. (e.g. dot-com bubble of the early 2000s, US housing bubble in 2000-2006). Part of the issue is that people may begin to follow the ‘wisdom of the crowd’; if they see professional investors buying into stocks, other people assume there must be a good reason for this.
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