Not at all. One example is charitable behavior. When National Public Radio holds a fund drive, they often announce a situation where a benefactor has agreed to match the contributions made over a certain time period. If you pledge money during that time period, your action raises twice the amount you contribute. These matching fund situations tend to increase the amount of contributions, because people respond rationally, even when they are giving money to charity.
The assumption of rationality—also called the theory of rational behavior —is primarily a simplification that economists make in order to create a useful model of human decision-making. If you consider your own personal choices, you will probably find that they are quite complex. You are balancing what you want right now with options you want to have in the future.
You probably value the people around you—friends, family, neighbors—and you may consider the impact that your choices have on them. When a consumer is thinking about buying a product, what does he or she want? The theory of rational behavior would say that the consumer wants to maximize benefit and minimize cost. Figure 2. Functional Functional.
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Pranay Kotasthane Follow. Indian National Interest An Indian public policy watering hole. In this lively article, the author, a professor of behavioral economics at Duke University, shows how the emerging discipline of behavioral economics can help businesses better defend against foolishness and waste. Smart organizations will develop a behavioral economics capability by hiring qualified experimenters and conducting small trials that build on one another, revealing a radically different view of how people make decisions.
Once an understanding of irrationality is embedded in the fabric of an organization, a behavioral economics approach can be applied to virtually every area of the business, from governance and employee relations to marketing and customer service. In , a massive earthquake reduced the financial world to rubble. Standing in the smoke and ash, Alan Greenspan, the former chairman of the U. We are now paying a terrible price for our unblinking faith in the power of the invisible hand.
If assumptions about the way things are supposed to work have failed us in the hyperrational world of Wall Street, what damage have they done in other institutions and organizations that are also made up of fallible, less-than-logical people? And where do corporate managers, schooled in rational assumptions but who run messy, often unpredictable businesses, go from here? We are finally beginning to understand that irrationality is the real invisible hand that drives human decision making.
Armed with the knowledge that human beings are motivated by cognitive biases of which they are largely unaware a true invisible hand if there ever was one , businesses can start to better defend against foolishness and waste.
The emerging field of behavioral economics offers a radically different view of how people and organizations operate. In this article I will examine a small set of long-held business assumptions through a behavioral economics lens.
In doing so I hope to show not only that companies can do a better job of making their products and services more effective, their customers happier, and their employees more productive but that they can also avoid catastrophic mistakes. Drawing on aspects of both psychology and economics, the operating assumption of behavioral economics is that cognitive biases often prevent people from making rational decisions, despite their best efforts.
Behavioral economics eschews the broad tenets of standard economics, long taught as guiding principles in business schools, and examines the real decisions people make—how much to spend on a cup of coffee, whether or not to save for retirement, deciding whether to cheat and by how much, whether to make healthy choices in diet or sex, and so on.
For the past few decades, behavioral economics has been largely considered a fringe discipline—a somewhat estranged little cousin of standard economics. Though practitioners of traditional economics reluctantly admitted that people may behave irrationally from time to time, they have tended to stick to their theoretical guns.
They have argued that experiments conducted by behavioral economists and psychologists, albeit interesting, do not undercut rational models because they are carried out under controlled conditions and without the most important regulator of rational behavior: the large, competitive environment of the market. Then, in October , Greenspan made his confession. Belief in the ultimate rationality of humans, organizations, and markets crumbled, and the attendant dangers to business and public policy were fully exposed.
Unlike the FDA, for example, which forces medical practitioners and pharmaceutical companies to test their assumptions before sending treatments into the marketplace, no entity requires business and also the public sector to get at the truth of things.
When organizations acknowledge and anticipate irrational behavior, they can learn to offset it and avoid damaging results. A few years ago, my colleagues and I found that most individuals, operating on their own and given the opportunity, will cheat—but just a little bit, all the while indulging in rationalization that allows them to live with themselves. We also found that the simple act of asking people to think of their ethical foundations—say, the Ten Commandments—or their own moral code before they had the opportunity to cheat eliminated the dishonesty.
Most individuals, operating on their own and given the opportunity, will cheat—but just a little bit.
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