How behavioral economics affects people's relationship with money or financial wellbeing, including hard data and facts about how behavioral economics prevents people or people be more mindful of their money or reaching goals.
- Counteracting the rational choice theory, behavioral economics explores the reasons people often make irrational decisions, especially when it comes to spending money or making purchases.
Slow Brain & Fast Brain
- According to Robert Schiller and George Akerlop, Nobel Laureates in Economics, the poor financial decisions can be explained by the slow brain and hard brain concepts - both under behavioral economics.
- A lot of people decide to make purchases before studying the pros and cons of making such purchases - called "slow brain." In addition, people tend to respond to immediate stimuli without reflecting - called "fast brain." Both can have severe consequences on their finances.
- For example, the way superstores are created forces consumers to go through the entire store. These consumers are then influenced by promotions and end up buying things they do not need, which could negatively affect their finances. These superstores have clearly incorporated behavioral economics.
Case Study 1: UK Personal Account Holders
- One example of how behavioral economics contributes to poor financial choices is in the UK.
- There are arranged overdraft and unarranged overdrafts for personal account holders in the country. These overdraft products help UK citizens avoid any potential negative financial consequences.
- Personal account holders in the country can apply for arranged overdrafts for a low fee, compared to unarranged overdrafts which have the same function but incur higher charges.
- Unarranged overdrafts help people to settle unexpected overdue bills. As a result, UK consumers tend to use unarranged overdrafts too often and underestimate the financial impact it could have on them.
- Around 37% of personal account holders in the UK have an arranged overdraft, compared to 25% who use an unarranged overdraft. Studies have shown that those who use an unarraged overdraft and incur higher costs while using it, tend to be young or live in low income areas.
How Behavioral Economics Can Help People Better Financial Decisions
- Economists assert that behavioral economics "show how to avoid falling into the traps of your brain."
- One trick economists recommend is getting to know your brain. This involves waiting a reasonable amount of time before making a purchase. This allows one to see if the purchase is necessary of if it is just an indulgence. Articles by the New York Times and Life Hack corroborate this concept. They advise that waiting 24-72 hours prior to buying something is a trick that helps financially.
- They also recommend getting advice from people prior to making a financial decision.
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