IB Economics 2.4.2 Behavioural Economics in Action Notes

Behavioural Economics in Action: Two Real Applications

1. Behavioural economics reaches real life through two applications that steer people without forcing anyone to act:
   1. Choice architecture shapes how the options are arranged and presented.
   2. Nudge theory uses small prompts in the environment to guide the decision.
2. Both rest on the same idea: people are not the fully rational calculators standard models assume, so the way a choice is framed changes what they pick.
3. Rearrange the frame and you change the outcome, even when every option stays available.

Choice Architecture

1. Choice architecture asks one question: how are choices presented to people?
2. The person who designs the menu, form, or default setting is the choice architect, and small design decisions change what most people choose.
3. It works through three types of choice:
   1. Default choice. A pre-selected option applies if the person does nothing, because many have no strong preference or would rather not decide.
   2. Restricted choices. The range of options is limited to steer people toward more beneficial decisions, while keeping some freedom.
   3. Mandated choices. The person must make an active decision, so inaction is removed even though the choice stays free.

Nudge Theory

1. Nudge theory creates small prompts or changes in the environment that guide people toward certain decisions.
2. A nudge leaves every option open and changes no prices, working by shaping the context around the choice rather than the choice itself.
3. A nudge has three defining features:
   1. Non-coercive. It removes no options and adds no penalties for choosing differently.
   2. Subtle. It works in the background, without people being fully aware.
   3. Cost-effective. It is usually a low-cost change that can lead to large shifts in behaviour.

How Automatic Enrolment Combines Defaults and Nudges

1. In the US, many employers offer 401(k) retirement plans, but when employees had to opt in, many never did and missed employer contributions.
2. Many companies switched to automatic enrolment, where employees are enrolled unless they opt out, and this single change combines every idea in this article.

Automatic Enrolment Helps Within Limits

1. Automatic enrolment works because it costs almost nothing and keeps every option open, but how much it achieves depends on how the default is set.
2. A higher default contribution rate lifts saving more, yet set it too high and more workers opt out.
3. Some extra pension saving comes at the expense of other saving, so the net gain is smaller than the jump in participation suggests.
4. There is also a fairness question, because someone still chooses the default and decides what counts as the better outcome for everyone else.
5. For retirement saving that case is strong, since most people say they want to save more but never get around to it, so nudges are a low-cost complement to policy, not a replacement for wages high enough to save from.