Behavioural economics has made its way into two main forms of real-life applications:
- Choice architecture.
- Nudge theory.
Choice architecture
Choice Architecture
The way in which options are showcased to decision-makers where there is emphasis on the design and environment to influence decisions.
Choice architecture focused on the following question:
How choices are presented to people?
Choice architecture differentiates between three different types of choices:
- Default choice.
- Restricted choices.
- Mandated choices.
Default Choice
Default choices are the pre-selected choices that apply if no action is taken. It is the decision made for individuals by default because people:
- Often have no interest or are not bothered in changing the choice already selected, even if it may not be the best.
- Sometimes, don't want to be the ones holding the responsibility of making the choice.
- In the UK, automatic enrollment into workplace pension schemes has increased participation rates from 55% to over 90%.
- This illustrates how default choices can nudge individuals toward decisions that benefit their long-term well-being.
Restricted Choices
Restricted choices are choices made in environments where the number of available options has been limited, where these choices:
- Guide people towards decisions that are considered more rational or beneficial.
- Still allow for freedom of choice, but they steer individuals in a particular direction.
- In France, supermarkets are prohibited from selling plastic cutlery, plates, and cups.
- This restriction nudges consumers toward purchasing reusable alternatives, reducing environmental waste.
Mandated Choices
Mandated choices are choices made when individuals are required to make a decision. When an individual makes a mandated choice:
- The choice remains free, but having to make a decision is mandatory.
- This approach ensures participation by eliminating the option of inaction.
In Australia, voting is mandatory, and citizens must declare how they will vote (in person or by mail). This mandated choice has resulted in consistently high voter turnout rates of over 90%.
Nudge Theory
Nudge
A method used to influence the decision of a consumer in a desirable way, without offering any financial incentives or imposing any legal regulations over them.
Nudge theory focuses on creating small prompts or changes in the environment to guide people toward certain decisions.
The main characteristics of nudges is that they are:
- Non-coercive: nudges do not eliminate options or impose penalties for choosing differently.
- Subtle: nudges often work in the background, influencing behaviour without individuals being fully aware of it.
- Cost-effective: nudges are usually low-cost interventions that can lead to significant changes in behaviour.
- Fly stickers in urinals: public toilets often place small fly decals in urinals to reduce spillage. This simple visual cue has been shown to improve cleanliness significantly.
- Healthy food placement: cafeterias place fruits and vegetables at eye level to encourage healthier eating choices.
- Opt-out systems: many membership programs, like workplace pensions, automatically enrol participants, requiring them to opt-out if they do not wish to participate.
- Traffic safety: speed cameras and painted lines on roads create visual nudges to encourage drivers to slow down.
Automatic Enrollment in Employee Retirement Savings Plans (US)
In the United States, many employers offer 401(k) retirement savings plans. Historically, employees had to actively opt into these plans by signing up. However, the behaviour of many employees showed that they often did not enrol, missing out on employer contributions and potential retirement savings. To address this issue, several companies adopted automatic enrollment in their retirement plans, with employees automatically enrolled unless they explicitly opted out.
Default Choice (Automatic Enrollment):
- Employees are automatically enrolled in the retirement savings plan unless they choose to opt out. The default choice is to participate, and research has shown that people are more likely to stick with the default option.
- Impact: The default choice significantly increases participation in retirement plans. By making participation the default, more employees save for retirement, improving their financial security in the future.
Mandate Choice:
- Although automatic enrollment is the default, employees still have the mandated choice to opt out if they do not wish to participate. The key difference between default and mandate is that employees must make an active decision to exit the program.
- Impact: While participation is the default, employees can opt-out, giving them the choice to act. However, the inertia of the default system makes opting out less common, thus increasing overall savings rates.
Nudges:
- The automatic enrollment system serves as a nudge that influences employees' decisions without restricting their freedom to choose. The nudge encourages employees to stay enrolled in the plan by making it the default.
- Impact: The automatic enrollment nudge leverages human tendencies like inertia and the desire to avoid making decisions, leading to higher participation rates in the retirement savings plan.
Outcomes:
- Increased Savings Participation: The automatic enrollment approach led to significantly higher participation rates. Many employees who would have otherwise failed to sign up or procrastinated are now enrolled by default.
- Greater Savings for Retirement: As a result of these behavioural nudges (default enrollment, limited choices, and nudging employees to stay in), more employees have begun saving for retirement, contributing to long-term financial security.
