Behavioural economics: seven principles for policy makers

This briefing summarises the behavioural economics approach and contrasts it with neoclassical economics, where the assumption is made that humans are rational and maximise their individual self-interest. It is designed to help policy-makers who use economic tools, by providing a summary of the latest thinking from behaviourial economics. It should also be helpful to the broader policy-making community by providing a theoretical underpinning for many policy approaches that have, up to now, been used intuitively.

Standard (neoclassical) economic analysis assumes that humans are rational and behave in a way to maximise their individual self-interest. This model of rational has many shortfalls that can lead to unrealistic economic analysis and policy-making. This briefing distills many concepts from behaviourial economics and psychology down to seven key principles, which highlight the main shortfalls in the neoclassical economics model of human behaviour:

• Other people’s behaviour matters: people do many things by observing others and copying; people are encouraged to continue to do things when they feel other people approve of their behaviour.
• Habits are important: people do many things without consciously thinking about them. These habits are hard to change – even though people might want to change their behaviour, it is not easy for them.
• People are motivated to "do the right thing": there are cases where money is de-motivating as it undermines people’s intrinsic motivation, for example, you would quickly stop inviting friends to dinner if they insisted on paying you.
• People’s self-expectations influence how they behave: they want their actions to be in line with their values and their commitments.
• People are loss-averse and hang on to what they consider "theirs"
• People are bad at computation when making decisions: they put undue weight on recent events and too little on far-off ones; they cannot calculate probabilities well and worry too much about unlikely events; and they are strongly influenced by how the problem/information is presented to them.
• People need to feel involved and effective to make a change: just giving people the incentives and information is not necessarily enough.

[author]