Behavioural economics challenges the rational actor model using psychology, offering insights into real-world decisions, biases, and innovative public policies.

Behavioural economics blends psychology and economic theory to explore how people actually make decisions—frequently diverging from the strictly rational models long held by traditional economics. Pioneered by researchers like Herbert Simon, Daniel Kahneman, and Amos Tversky, the field identifies emotional, cognitive, and social influences that shape decision-making. With implications across public policy, health, finance, and education, behavioural economics is a cornerstone of applied social science today.

Core Principles

Heuristics and Cognitive Biases: Heuristics are mental rules-of-thumb used in decision-making, often leading to systematic errors or biases. Common examples include the availability heuristic (estimating probability based on memorable events), anchoring (over-reliance on initial information), confirmation bias, and the endowment effect. These biases affect everything from shopping and investing to voting and risk assessment.

Prospect Theory: Developed by Kahneman and Tversky, prospect theory challenged classical utility theory by showing that individuals perceive losses more strongly than gains of equal size—a principle called loss aversion. Moreover, individuals weigh probabilities non-linearly, leading to inconsistent choices depending on how options are framed. This theory has been validated in numerous experiments and is foundational in behavioural finance and consumer psychology.

Nudges and Policy Implications: Popularized by Richard Thaler and Cass Sunstein, nudge theory focuses on designing "choice architectures" that subtly steer people toward better decisions without removing freedom of choice. Applications include placing healthy food at eye level, automatic enrolment in pension plans, and default organ donor registration. Many governments have established behavioural insight teams to apply these strategies to public administration.

Public Health and Broader Applications

Behavioural science has significantly influenced public health policy, notably in improving vaccination rates through reminders and reframing consent systems to "opt-out" for organ donation. Educational programs based on commitment devices and goal-setting have improved academic performance and attendance. These low-cost interventions demonstrate the power of behavioural economics to achieve scalable policy outcomes.

Critiques and Future Directions

Despite its impact, behavioural economics faces criticisms around external validity—most findings originate from controlled, low-stake environments and may not generalise to complex real-world decisions. Scholars like Gerd Gigerenzer argue that heuristics are often adaptive rather than flawed. Bridging behavioural insights with traditional models remains methodologically difficult. However, advancements in technology, such as AI-powered personalised nudges and digital feedback platforms, promise scalable and context-sensitive behavioural interventions.

Behavioural Finance: A Case Study

Behavioural finance applies psychological insights to market behavior. Investors frequently exhibit overconfidence, herd behavior, and recency bias, which can distort markets. Financial advisors use behavioural strategies—like goal framing, mental accounting, and commitment contracts—to help clients stick to long-term financial plans and reduce impulsive actions.

Conclusion: Behavioural economics enriches our understanding of economic behaviour by replacing assumptions of perfect rationality with empirically grounded models of decision-making. By integrating concepts like heuristics, loss aversion, and choice architecture, it has transformed economic theory and policy alike. As digital tools evolve, the next wave of behavioural economics will likely combine AI and ethical design to foster well-being across domains, while confronting challenges around validity, scalability, and transparency.