years, it has been possible to understand the nature of a number of these
biases – or deviations from rational decision making – which now support many
of the propositions of what has become known as ‘behavioural economics’. For
example, people have been found to have:
Cognitive limitations (‘bounded rationality’) –people cannot collect and process all the available information
potentially relevant to making a rational decision.
People simplify decision
making by adopting simple heuristics (or procedural rules-of-thumb); for
example, simplifying the problem by focusing only on price and style (ignoring
People may rely on the first
piece of relevant information they receive; for example, the first in a list on
a comparison website.
People are influenced by the
way a choice is presented to them (framing) even when the alternative
presentations are equivalent; for example, preferring A over B based on the
quality and prices of the goods, but reversing this preference presented as
‘50% off’if B’s price is.
Biased beliefs – people
often act as if they distort objective information on probabilities
tend to place a greater weight on both very low probability events and on
certainty; for example, buying both lottery tickets and expensive insurance
that covers 100% replacement.
How firms can exploit behavioural traits
With fully rational consumers, it
is usually advantageous for firms to provide potential customers with all the
relevant information on product specifications and price. However, with
behavioural consumers, firms may find advantage in obscuring information so
that consumers pay a higher price or buy a lower quality than would be best for
them. Consumers may be provided with too little information to make an
appropriate comparison with alternatives. Perhaps paradoxically, the same
effect can be achieved by providing too much irrelevant information such that
the decision-relevant data is buried in the small print and so ignored. Firms
can also adapt their pricing strategies to take account of the fact that their
potential customer base may include both rational and behavioural consumers.
most consumers compare prices, they do not necessarily pay attention to the way
prices are presented to them. The only information that should be relevant to
customers is the final price they have to pay. However, that is not always
obvious because firms sometimes present information about the final amount
charged in ‘drips’, with insurance, credit card fees, baggage charges, etc.
added on only after the emotional commitment to a purchase has been made.
Similarly, people can be caught by a time-limited offer that runs out just
before purchasing, but they can no longer be bothered to search for a better
also be presented in a way that makes them appear particularly attractive.
Consumers may believe a ‘half price’ offer must be good value even though the
previous price was twice as much as the price at which it could have been
purchased elsewhere. ‘Buy one get one free’ also sounds like a great deal, but
it may not be if the price of one unit is inflated or the second unit would not
have been purchased otherwise.
Retailers are experts on how
consumers respond to these alternative pricing strategies, and can sometimes
use them to benefit at the expense of consumers. This should not be taken to
imply that such offers are always bad for consumers. Genuine price cuts are an
essential part of the competitive process. Behavioural economics provides
insight into how various price obfuscations can be used strategically, but
individual examples need careful appraisal before deducing that a pricing
strategy is anticompetitive in a particular market.
What remedies are appropriate for an
intervention founded on behavioural economics?
can identify a market where customers are prevented from choosing their
preferred product because it is difficult to obtain and process the right
information. Once such a market failure has been identified, we need to
consider whether it can be corrected without creating a new distortion. The
best economic advice for intervention, as always, is to act as close to the
source of the problem as possible. For example, suppose information is being
presented in a way that obscures the key decision-relevant facts, typically
including the final price that has to be paid. An appropriate intervention
would be for firms to be required to highlight such information up-front in a
clear and transparent manner. The aim is to help consumers act more closely in
line with the rational ideal that makes a competitive market attractive –
consumers get the product they want and at a price that reflects cost. Remedies
that require clearer provision of information to final consumers may increase
costs a little, but they are unlikely to have additional consequences that are
harmful. Greater care is needed for other remedies which directly interfere
with consumer choice.
Remedies designed to change
consumer behaviour are increasingly used by the UK competition authorities.
of transparent price information to facilitate price comparisons:
airlines were adding additional payment card charges to headline prices for
flights, even when cards were necessary to make a purchase. Consumers only
discovered this late in the booking process so it was difficult to compare
prices. The OFT used consumer protection legislation to require airlines to
include debit card charges in all headline prices, both on the airline’s
website and in its advertising. Additional credit card fees are permitted as
long as they are presented clearly and transparently. It is now easier for
consumers to compare prices before getting committed to a particular flight.
An interest rate can be
calculated in many alternative ways. Lenders are required to present interest
rates for consumer loans in a standard form known as APR (annual percentage
rate). It is arguable whether APR is the best way for a consumer to understand
the cost of a loan, but it does provide a standard by which the offers from
different lenders can be sensibly compared, and so facilitates competition.
Restrictions on marketing
complementary products, such as insurance, at the ‘point of sale’.
protection insurance (PPI) is mostly sold at the same time as a consumer takes
out a loan (‘point of sale’). Customers could buy PPI from a separate provider
but they almost never shop around because they are either unaware that it is
possible or worried about a gap in coverage or simply cannot be bothered. This
confers a near monopoly advantage at the point of sale, and the absence of
competitive pressure allowed very high prices to persist.
Sense of Complex Choice Situations
The idea is
that firms sometimes price their products, or present information about their
prices, in unnecessarily complex ways, and that this complexity obstructs
competition and exploits consumers.
In many cases, these innovations
have led to greater economic efficiency in pricing. For example, it is now
possible for airlines to vary the prices of seats on individual flights minute
by minute so as to match demand to supply, reducing the waste of empty seats.
Products that were previously sold as single-price packages can now be more
easily broken down into separately-priced components, allowing purchases to be
tailored to consumers’ individual requirements. As the example of airline
prices also illustrates, price discrimination has been made easier.
Minute-by-minute price flexibility allows higher prices to be charged to
passengers who do not want to commit their travel plans far in advance and who
are not willing to substitute a cheap destination for an expensive one. But
this, too, can be seen as efficiency-enhancing, since price discrimination
helps to ensure that goods are supplied whenever the total benefits to
consumers exceed the cost of production.
overload is said to occur when consumers face so
many options that the quality of their decisions declines, or they feel
dissatisfaction with their final choices, or their motivation is so undermined
that they avoid choosing altogether. An extreme version of this claim has been
popularised by Barry Schwartz (2004) in a book whose premise is that when the
number of options becomes too large, ‘choice no longer liberates, but
Influences on Behaviour
learn both from their own experiences and from observing the experiences of
others and how these may contribute to welfare.Imagine that we see someone we
trust or like, they are eating at a restaurant and so we decide to eat there
too. This is a social influence on individual behaviour. It could have arisen
in two distinct ways. We could have been looking for somewhere to eat and taken
the person’s presence in the restaurant as a reliable indication that this was
a good place to eat. Alternatively, we could have had no prior intention of
eating at a restaurant, but we identify with this person and the group that he
or she belongs to; they are part of our set and so we decide to eat at this
restaurant too, as this is what our group does. In the one case, the behaviour
of others transmits useful information about how best to satisfy our desires
and we act on this information. In the other, our desires or preferences are
influenced by those we associate with, and that is why we follow what they do.
This vignette raises the question of how the presence of such social influences
might create opportunities and set challenges for policy.
can also arise when the value to an individual of consuming something depends
on the number of other people consuming it. In this case, the behaviour of
other people can be a source of information of a rather different kind. When we
watch a film or TV programme or we go to an exhibition, part of the pleasure is
experienced at the time of consumption; but part of the pleasure comes later
from being able to discuss the experience with others. Critically, this later
pleasure depends on whether others have also seen the film, watched the TV
programme, and so forth. As a result, it can make sense for individuals to
prefer to watch what others are watching even when their natural tastes might
point them in a different direction. This is sometimes called the water-cooler
effect because of the way that people in offices often congregate in
communal spaces for a chat.
The report mainly deals
with marketing implications of behavioural economics. First part of the report
discuss about behavioural economics and how it is different from traditional
economics. Behavioural economics can help to explain why search and switching
costs might arise, and how consumers actually make decisions. From a regulatory
perspective, however, understanding such processes is important only as a means
to an end.