How Reality Affects Rationality

Rationality, predictability and utility maximization are indispensible factors that guide the framework of standard economics. These factors contribute towards our understanding of economic flux in an idealistic world, and are hence considered important while defining the basic laws of economics. In reality, however, decisions made by humans may be influenced by psychological and emotional factors which lie beyond the scope of standard assumptions in economics. The concept of behavioural economics plays an instrumental role to complement this void in standard economics. It tries to amalgamate psychology and economics to understand the reasons behind irrational decisions made by humans which hinder predictability and thwart utility maximization.


How does behavioural economics work?

The notion of idealistic, calculated and risk neutral behaviour goes for a toss, when people make decisions with ‘bounded rationality’. The idea implies that there exist limits up until which rationality in decision making is exhibited, beyond which, cognitive factors may disproportionately drive the decision making process. For example, when shopping for a particular product in a mall, customers may not have sufficient time and resources to compare every single product available in the required category. In such a situation, lower pricing, larger quantity, better brand perception, or merely greater product visibility on shelf, may be the factors on which the buying decision is based.

‘Prospect theory’ adds another layer to this idea, by considering the unequal value that humans associate with perceived gains and losses. The theory demonstrates that in a decision making situation, people tend to be risk or loss averse and prefer certainty of returns. For example, in a probability game, if one option offers a certain pay-out of $100, while another option offers a 75% chance of winning $150 and a 25% chance of winning nothing, then individuals tend to select the first option, even though it has a lesser statistical expected value as compared to the other option. This happens because the certainty of $100 pay-out is highly valued and individuals try to avert the risk of perceived loss at 25% chance.

Similarly, choices can be impacted by comparison of obtained gains to certain reference points that individuals have in their mind, such as, the possible gains from other choices or gains obtained by other individuals. Moreover, behaviour associated with social preferences like fairness, reciprocity, equity, etc. may further influence a customer’s choices. For example, a company may run a campaign wherein for each product sold, a certain sum of money would be donated for a social cause, and customers may find such a campaign appealing enough for their decision making process to be influenced.


How is behavioural economics leveraged for marketing?

When marketing different product or service offerings, businesses often utilize the above mentioned factors to drive customers towards purchases. Some of the methods adopted are as follows:


        The Nudge Factor :

This method involves manipulation of the environment surrounding the decision making process, such that it prompts or ‘nudges’ the customer towards predictably making one choice over other. For example in retail outlets, impulse buying is nudged onto the customers when they are on their way to checkout or billing counter, by placing chocolates or other sweets right next to the counter. Here, customers tend to be not as critical towards considering their buying decision as they were during the in-store shopping, and a tempting, attractive, sugary treat easily sways them into making a purchase. The online shopping or e-commerce version of this method is the display of ‘frequently bought together’ items or other complementary items while customers are on their way towards the check out.


      • Framing of Choices : 

Choice architecture can also be tweaked in ways that can persuade customers to make certain purchases. The Decoy effect is a well-known example of this and is most popularly demonstrated with the help of popcorns sold at movie theatres. While buying popcorn, if only two sizes of popcorn buckets are available, namely a ‘Small’ size for ₹ 49 and a ‘Large’ size for ₹ 99, then the ‘Large’ bucket appears relatively expensive and does not sell as much. However, if a third, decoy item is introduced as a ‘Medium’ size option with a price of ₹ 89, then the ‘Large’ option begins to appear as the best choice, and this may increase its sale. Customers can thus be persuaded towards one particular choice by introducing a disproportionately priced decoy item. Following illustration depicts the same.




      • Default Bias :

When choosing from several options, customers are more likely to maintain the status quo and go with the default option, if provided. This happens as people tend to feel more relaxed and secure about not having to deal with evaluating all the options or actively deviating from the status quo and attracting potential risks. For example, customers using a web service often
subscribe for receiving emails and marketing messaging as it is set as the default, pre-ticked option, which they rarely take the trouble to change. Similarly, subscription plans set as default option under ‘our recommendation’ or ‘most popular’ tags, add credibility to the already risk averse option and may obtain a higher subscription rate.


       Priming Effect:

This effect involves influencing decisions of customers by subconsciously directing their behaviour. This can be done by setting up subtle visual, auditory or olfactory clues in the environment, such as, use of certain scents or suggestive music, use of a ‘premium’ or ‘bestseller’ tag on products, etc. Advertising plays an important role in conveying this effect as priming can also be used for creating positive association between a desired attribute and your brand. Such associations, if developed using sensory stimuli, can be used to trigger a desire for buying from the brand upon sensory stimulation. For example, the tagline ‘Red Bull Gives You Wings’ may help establish an association between the Red Bull brand and the feeling of being energized and customers may more often choose to buy Red Bull, whenever they feel fatigue or weariness. Red Bull drives this idea by hosting, sponsoring or advertising in adventure sports and events, an illustration of which has been shown below.


It is thus evident that several marketing techniques have been developed to account for the behavioural aspects in economics which can introduce substantial changes in business offerings. Marketers are always on the lookout for new opportunities to influence customer behaviour in a favourable way and implementation of behavioural economics can certainly prove to be a useful tool in this endeavour.

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