Thinking Like an Economist
When the new study design for VCE Economics was implemented in 2017 one of the most exciting additions was the opportunity to study the field of behavioural economics. Behavioural economics is a subset of the study of economics that challenges some of the assumptions underlying traditional economic models of supply and demand. For example, traditional economics assumes that people always behave rationally, have access to perfect information regarding products and prices and will always act to maximise their income. Behavioural economics argues that an individual’s ability to make rational decisions is influenced by their peers and advertising, their ability to access information regarding prices and quality is bounded and although they do try to maximise their income they also value characteristics such as fairness and being a good citizen. So in essence, behavioural economics is about how people actually behave in the real world, rather than how economic models assume they will behave.
Probably the most famous behavioural economist is Richard Thaler. Richard has been referred to as the father of behavioural economics and won the Nobel Prize for Economics in 2017 for his contributions to the study. In his book, Misbehaving he talks about a list he made called “dumb things people do”. It was basically just a list of examples of individuals behaving like normal human beings, but traditional economics would argue that that this type of behaviour was irrational and would never occur. For example, one item on the list referred to a bottle of wine. Richard knew a professor who had a firm rule that he would never pay more than $30 for a bottle of wine. In the professor’s wine cellar were several bottles of wine that he had bought for about $10 but had now aged into $100 bottles of wine. However, the professor claimed that he would never sell those $100 bottles of wine and preferred to save them to drink on special occasions. To a rational economist, this does not make any sense. Given that he was not prepared to buy a bottle of wine over $30 he should also not be willing to drink a $100 bottle of wine. Given that he has the opportunity to sell the wine for $100, he has effectively paid $100 for something he claimed he would never buy. Richard’s list contained lots of examples such as this where people were breaking the basic rules of traditional economics.
Inspired by Richard’s earlier book Nudge, the United Kingdom’s Behavioural Insights Team (BIT), or ‘Nudge Unit’, was created by Prime Minister David Cameron in 2009. A nudge is a way of encouraging people to make better decisions but without placing any limits or restrictions on those choices. The Nudge Unit’s purpose is to apply behavioural economic theory to try and improve government policy and services. One of the most well known nudges implemented by the BIT was nudging people to pay their taxes on time. Instead of the standard letter reminding people who had not yet paid their taxes to please do so, the letter was reworded using insights from behavioural economics. It said something along the lines of “Nine out of 10 taxpayers in your area pay their tax on time, you are in the minority”. The newly worded letter used the nudge of peer group comparison and was far more effective.
As part of our Unit 1 Economics course at St Catherine’s School, we will be exploring these and other examples of nudges such as opt out versus opt in organ donation and pre-filled income tax forms in Australia. Students will also be given the opportunity to create our own ‘Nudge Unit’ and conduct experiments to investigate hypotheses such as “would incentives encourage students to put their rubbish in bins?” and “are students with surnames beginning with A–G more likely to do their homework than students with surnames H–Z?”. Hopefully, by the end of this unit students will be able to look at the world in a different light because they have begun to start thinking like an economist.