Behavioral Economics and Our Emotional Decision-Making

behavioral economics Economics often depends on people doing logical and rational things with their money so the markets perform in a predictable way. According to the Library of Economics and Liberty, “traditional economics conceptualizes a world populated by calculating, unemotional maximizers…” If only! If you have ever observed a bubble or other consumer behavior, you might wonder about the calculating and unemotional part.

*Please join us Friday, January 4th at 5pm BST/12pm ET/9am PT for the Twitter chat, #KaizenBiz as take a look at the business trends of 2012 and what might come in 2013. Not sure how to participate? Please click here for tips and advice.

Quick primer

Behavioral economics uses psychological, sociological and economic theories to explain why people, organizations and other large group systems do what they do with their money. Behavioral economics was founded by Nobel Prize winner,  Daniel Kahneman. Kahneman and other behavioral economists point out that humans are, well, human. We have cognitive biases, emotions and other quirks along with our rational thinking patterns that influence our decision-making process. (There is a very interesting chapter on the Role of Emotions In Economic Decisions from Handbook of Emotions, Third Edition by Scott Rick and George Lowenstein) In a nutshell, behavioral economists asked why people do what they do while neoclassical economists have left out the “why” and focused on the concept that people use objective information and reason to create outcomes.

How could these behaviors affect business practices and decisions?

So when I saw the interview (hat tip to KaizenBiz team member, Cathy Larkin) with Scott Robbin, senior content associate at Argyle Associates and Ed O’Boyle, global practice leader at Gallup, I noted that Gallup was applying behavioral economics.

O’Boyle described how companies may offer a feature to customers. It can be obscure or not. However, if the company goes to change or remove this feature, there is often a dramatic response from their customers. According to O’Boyle, customers will still want the feature even if they don’t intend to use it.

There could also be a backfire effect for companies who introduce fees for use when previously they did not charge.One such example occurred in the US when banks stated they would charge for use of debit cards. Customers showed their displeasure by moving to smaller banks or credit unions, even when the fees would not apply to them. This decision is emotionally based decision.

Customer engagement is very much based on how the emotional needs of the consumer are being met by a company. As in, if you treat me well when I buy something from you as well as when I complain to you then I will remain a customer. Even if this means I pay more for your product or service than your competitor down the street. Customers perceive value and will pay for it. Now, if you follow the traditional economic model, there is no unemotional maximizer in this situation. Perception and emotional gratification are driving the economics.

Understanding at a visceral level?

When we speak about consumer habits and marketing, we are actually pointing to behavioral economics.. Sure, there is still supply and demand. Economics is economics even if there is a psychological and sociological explanation. But it is a challenge for most of us as we watch the Eurozone cope with austerity and potential defaults, the US financial policies and the slowing of the BRIC countries. And yet, in The Spectator, there is an article about how 2012 was the best year ever. It might not be so weird that it is more prevalent for business to engage in corporate social responsibility, seek to engage in conversation with their customers online or offer access to goods rather than ownership. Perhaps on a visceral level, we all know that emotions play a huge part in our decision-making. Why not with economics?

To what degree do we underestimate the power of emotions in our thinking and decision-making?

How can an understanding of behavioral economics be used to help a business connect with its customers more effectively?

How does this change your perspective of economics if people are both rational and irrational in their decision-making?

How could applying behavioral economics affect strategic decision making?

What could be downsides to using behavioral economics in high-level business decisions?

How could non-violent political crisis and social unrest change consumer behavior?

About the author:  Elli St.George Godfrey, founder of Ability Success Growth and small business coach/trainer, is the host of KaizenBiz. I’m passionate about business becoming a more human-centered place so I host this chat to connect business ideas and develop people.This passion shows up in my work with my clients. Whether you are expanding in your own backyard or into another country, Ability Success Growth guides established small business owners to unlock the CEO within during times of transition and growth.

iStockphoto by adventtr