Psychology is used by economists to explain individual human behavior when an economic model cannot predict or explain a person’s decision. To help explain an individual’s decision, it’s helpful to understand the thought process and emotions that go along with making a decision. The study of psychology and its relation to economics is called behavioral economics.
Edward Bernays was hired to help increase demand for the Beech-Nut Packing Company, who were big pork producers in the 1920s. Bernays thought that if one could figure out a person’s utility function (preference) or motivation, then it would be easier to persuade them to buy a product with marketing incentives. Bernays surveyed several doctors to ask whether a “hearty” breakfast was better than a light breakfast. He then released the survey results to the public, showing that heavier breakfast options, like bacon and eggs, were healthier than a light breakfast. He used an indirect approach to influence the public’s decisions about their diet, and this brought the Beech-Nut Packing Company many new customers. His approach best describes nudge theory, a concept in behavioral science and economics which suggests positive reinforcement and indirect approaches to influence behavior and decision making of individuals.
Something that might prove helpful with influencing behavior of people is learning what motivates/influences them. There are many different possible influences a person may have that affects their decisions. Someone’s decision could stem from altruistic motivations (like choosing to donate to a charity rather than buying a car), or possibly they decide to do something as a result of a past experience. It is also very common for one’s cultural background to impact whether or not they buy a product from a certain company. For example, the Quran, the religious text of Islam, holds a lot of influence on the dietary decisions of Muslim followers: a product might be considered “halal” (permissible) or “haram” (forbidden).
A person’s culture has a lot of influence on their identity, and a person’s identity has a lot of impact on their decisions. I am currently reading a book called Identity Economics, by George Akerlof, which discusses exactly how identity influences decision making. One of the many things mentioned are social norms and a person’s social category. A person’s identity, whether it’s based on a cultural alignment or something else entirely, defines their social category, and that category has a set of expectations, or social norms. People of a certain cultural group may try to make decisions that live up to those expectations. This can also be true for children who grow up around a certain culture or standard because children are very quick to pick up social norms. A child who is thirteen years old will make different decisions than a child who is ten years old because they want to be seen as more mature. Even if they want to buy the unicorn stuffed animal, they instead buy something that is “age appropriate,” because they know that’s what is socially expected of them. Another example would be a girl will buy the pink car instead of the blue truck because she picked up on the expectations for different genders. Social norms and expectations lead to marketing strategies with specific demographics directed to a specific group of people.
The concept of behavioral economics gets a lot of criticism, and one of the arguments is that the ethics of influencing someone in this way can violate certain liberties, and it could be considered manipulative. However, in the case of 401k’s it seems that the study of behavioral economics can also benefit the person being influenced. For example, there have been multiple studies about how behavioral economics can influence a person’s 401k and help them to make decisions that allow them to save more money. One specific example is that 91% of employees choose not to opt out of a 401k when their company auto-enrolls them, helping many employees save their money. This proves that using incentives and behavioral economic theory doesn’t necessarily have to be manipulative, it can also be beneficial.
By studying cognitive biases and behavior, economists can apply psychological theories to economics to help influence an individual’s financial decisions. Using certain information, like a person’s identity, combined with behavioral economic theory would be very beneficial in finding that person’s motivation or preferences, which results in being able to set up a successful incentive.