The influence of behavioural economics on decision making

In our previous blog, we learned that consumers don’t always act rationally when making financial decisions. But can the “rationally irrational” be influenced? Behavioural economists think so.

Picture this: you are shopping late at night for just the right snack. You find the potato chip aisle and proceed to locate your favourite brand. However, on the shelf next to your favourite, is the store’s generic version. You notice it is a full dollar cheaper than your usual go-to snack. What do you do?

Behavioural economists use the following concepts to predict and influence a consumer’s decision-making process.

Lack of information

You’ve never tried the generic brand before, and given how much you are looking forward to your treat, you’d hate to be disappointed. You don’t see a sample available to try, and you don’t know anyone you can call or text, who might have tried the cheaper alternative. There is no picture on the bag of the product, and you can’t see inside. Given the lack of available information, you aren’t sure which snack to choose.

Psychology of price

You’ve already noticed that the generic brand is a dollar cheaper, but you wonder if that might be an indication of a poor-quality product. In general, consumers feel a higher-priced item indicates a higher level of quality. Studies in pricing have revealed that merchandise priced significantly lower than expected can signal to consumers there is something amiss, and push them towards higher-priced alternatives.

Heuristics

Heuristics are mental shortcuts consumers use in making decisions. They effect decision making in every aspect of life, and the resulting errors are called “cognitive biases.” In our potato chip example, you are faced with many criteria on which to evaluate the decision. Since you can’t make a judgment about the flavour, you carefully study the packaging. You then notice that the generic bag is larger than your preferred snack, and so now you also have to determine which snack offers better value. Your decision is now about much more than a snack – you are considering value, quality, and risk. Faced with multiple criteria, you may choose to rely on a mental shortcut (i.e. buy the brand name product) which does not consider all factors, resulting in a decision that is not the most rational economic choice.

Nudge theory

The grocery chain has carefully placed the generic alternative next to the national brand on purpose. Economists would classify this product placement as an application of “nudge theory.” The store is nudging you to consider alternatives to your traditional choice, by placing them in close proximity. It is likely that if the generic option was on the bottom shelf, you may not have even seen it. Nudge theory is a careful consideration in grocery store design, and has been successfully used in school cafeterias to encourage children to choose healthy lunches. By placing sugary treats in less visible locations (i.e. the top shelf in a cooler), and instead placing healthy alternatives in direct line of sight, research has shown that children more frequently choose the healthy alternatives.

Behavioural economics can be applied in many areas such as politics, public policy, education and marketing. Understanding how these factors work to influence decisions is an important part of becoming financially literate. CPA Canada’s Financial Literacy education seminars, tools and resources can strengthen the financial capability of Canadians.

Keep the conversation going

Can you think of a time when your choice was affected by lack of information, pricing, mental shortcuts or product placement (nudge theory)? Post a comment below.

Disclaimer

The views and opinions expressed in this article are those of the author and do not necessarily reflect that of CPA Canada.

About the Author

Crystal Buhler, CPA, CGA, CIRP

Crystal is a Licensed Insolvency Trustee (LIT) with Keith G. Collins Ltd. Crystal is licensed to act as an LIT in administering bankruptcies, to administer proposals pursuant to the Bankruptcy and Insolvency Act, and to act as a financial counselor. She is a member of the Canadian Association of Insolvency Restructuring Professionals (CAIRP).