Motivation and emotion/Book/2013/Behavioural economics and habits

Behavioural economics and habits:
How can behavioural economics be used to understand and change habits?

Multimedia presentation (5 min)

Overview

Imagine that it is the night before an important university assessment is due. You are a good student, and it is important for you to do your best and obtain a good mark. In the back of your mind you know you should start working on it, and at the same time you are afraid that you will not have enough time to complete it and do well. Before starting, you conclude that you should first clean your bedroom, drive to the store to pick up some groceries, give your dog a bath (as he really needed it) and also put on a load of washing. You know that perhaps the rational decision here would have been to spend all possible time working on and perfecting the assessment, yet for some reason you continue to complete minor tasks that are probably not as important. You wonder why you have left this until the last minute, and recall that this is not the first time you have done this, in fact it is becoming a habit.

We as humans make decisions based on information around us, although sometimes the decisions do not always appear rational or beneficial. Behavioural economics is key in understanding what motivates us to make these decisions. In this chapter you will learn the economic principles that can be applied in conjunction with what we know about human decision-making. We will discuss how we can be susceptible to cognitive biases (errors in judgement), and how to use this knowledge to better understand and change our habits.

Behavioural economics

Behavioural economics is a relatively new field that attempts to explain how people behave and why they make the behavioural decisions that they do (Heap, 2013). Traditional economics assumes that individuals are rational decision makers, and that the decisions that we make are to maximise our own happiness (Becker, 1962). Behavioural economists study why people make decisions that do not always appear rational, with an emphasis on cognitive processes and biases that impact on our decision-making (Heap, 2013).

Key concepts

Choice as a concept choice describes how an individual weighs up the pros and cons of a behaviour, in relation to other alternatives (Staddon & Cerutti, 2003). Kahneman & Tversky (1979) performed an experiment that investigated the effect of choice by giving participants the option of receiving a guaranteed $400, or the option of a 50% chance of receiving $1000. Majority of the participants opted for the guaranteed $400, and this introduced the idea of the idea of risk aversion: opting for a sure thing rather than taking a risk that could result in a negative outcome (Staddon & Cerutti, 2003). Kahneman & Tversky used the cognitive processes that people were displaying - evaluating gains and losses - to develop the Prospect Theory (Kahneman, 2012). Choice also plays a role in the theory of delay discounting which explains that people are more likely choose a small reward that is delivered immediately over a large reward delivered after some delay (Field, Santarcangelo, Sumnall, Goudie & Cole, 2006). Risk aversion and delay discounting are among some of the key theories of choice that are taken into consideration by behavioural economists.

Expected utility theory explains how people tend to analyse all potential outcomes before settling on the most rational choice, with a focus on the outcome (Kahneman, 2012).

Rationality is the process of how an individual considers all options to solve a problem and opts for "the best choice" (Kahneman, 2012). A rational agent supposedly always opts for a decision that provides an outcome with the most benefit to the self, compared with all other outcomes (Kahneman, 2012). Examples of rational agents include people, companies and computer programs (Kahneman, 2012).

Prospect theory was developed in 1979 by Kahneman and Tversky as an alternative to expected utility theory (Kahneman, 2012). In contrast to expected utility theory, prospect theory explains that people make their decisions based upon evaluation of all potential gains and losses rather than a focus on the outcome. This theory can help explain why sometimes we are motivated to make a decision with a rationale of "it's better to be safe than sorry", we often prefer to avoid potential losses rather than focus on what we can gain.

Heuristics are "rules of thumb" people use to make decisions in circumstances where the situation is complex or lacking in details (Kahneman, 2012). They are considered simple rules or mental shortcuts that people have learned over time that allow for quick decision-making and problem solving (Kahneman, 2012). Although heuristics are often useful and save time, they can also lead to cognitive biases, or errors in judgment (Kahneman, 2012).

Three common judgment heuristics that can lead to errors are:

Representativeness heuristic: making a judgment about the probability of an event based on how it appears to be similar to something that is expected. This means, an individual takes in the surroundings and makes a judgment of the situation based on how likely this situation is to occur. For example, if a person walks into a hospital and sees a man in a white lab coat, the person is likely to assume that the man is doctor.
Availability heuristic: using readily available knowledge to assess the probability of an event occurring, introduced by Tversky and Kahneman in 1973. For example, when people overestimate the likelihood of shark attacks due to recent media coverage of shark attacks.
Anchoring and adjustment: focusing too heavily on an initial piece of information during decision-making or judgements of a situation.

How does behavioural economics differ from traditional economics?

Traditional economic principles assume that individual preferences and choices are rational and remain stable (Rabin, 1998). Therefore, in a given situation an individual will act in a way to maximise their own happiness. It also means that preferences are taken as given (not context dependent), well-defined and constant over time (Becker, 1962). For example, if a person chooses to buy a chocolate over an apple it is assumed that the person just prefers the chocolate. This means that other variables such as positioning and product display is not taken into consideration.

Behavioural economics incorporates psychology and sociology in association with traditional economics (Stern, 2000). Behavioural economists try to take into account all other variables that influence decision-making. In other words, it is a field that explains why people make decisions that are not always in a way to maximise their own wellbeing and act in ways that can be seemingly contrary to their own interests. Furthermore this field attempts to explain why an individual's behaviour may differ from behaviour predicted by a previously established economic model, such as those explained using expected utility theory. For example, we could rationally weigh up the likelihood of gaining something versus losing something, but either way we are more likely to make a choice that favours avoiding a risk that could result in a loss.

Cognitive biases

Traditional economic principles were questioned when Dr Daniel Kahneman introduced the role of cognitive biases in decision-making. Cognitive biases can occur when people make decisions based on limited information. This can lead to a distorted perception, bad judgement or inaccurate interpretation of a situation (Haselton, Nettle & Andrews, 2005). There are two categories of cognitive biases adapted from Kahneman's research: Information biases that reduce information-processing time such as heuristics, and Ego biases that are influenced by social norms and can be motivated through emotions such as fear or anger.

Table 1 Information and ego biases (Psychology Today, 2013)

Category:	Bias:	Elaboration:
Information	Knee-jerk bias	Making a quick decision in a circumstance where slower, more precise decision-making is needed.
	Occam's razor	Assuming that an obvious choice is the best choice.
	Silo effect	Using a narrow approach to form a decision.
	Confirmation bias	Only focusing on the information that confirms your beliefs (and ignoring disconfirming information).
	Inertia bias	Thinking and acting in a way that is familiar or comfortable.
	Myopia bias	Interpreting the world around you in a way that is purely based on your own experiences and beliefs.
Ego	Loss aversion bias	Tending to favour choices that avoid losses, at the risk of potential gains.
	Shock-and-awe bias	Believing that our own intelligence is all we need to make a difficult decision.
	Overconfidence effect	Having too much confidence in our own beliefs, knowledge and abilities.
	Optimism bias	Being overly optimistic and underestimating negative outcomes.
	Force field bias	Making decisions that will aid in reducing perceived fear or threats.
	Planning fallacy	Incorrectly judging the time and costs involved in completing a task.

Habits

Habits can be described as consistent actions that either encourage or prevent a behaviour (Stern, 2000). Habits are generally considered to be constant, ongoing processes that are relatively stable. They are repetitious actions or behaviours that people learn and perform, often at a subconscious level. Futhermore, they can be positive, such as healthy eating habits, or negative, such as nail biting.

Development of habits

Before initially performing a behaviour, we usually consider all planning needed prior to the action being performed (Lally, Van Jaarsveld, Potts & Wardle, 2010). As this behaviour is carried out more and more in the same setting, we often become automatic in performing it and rely less on planning (Lally, Van Jaarsveld, Potts & Wardle, 2010). This automatic repetition strengthens and becomes an association between an environmental cue and the subsequent behaviour (Lally, Van Jaarsveld, Potts & Wardle, 2010). For example, the first time you drive a car you may sit in your seat and consider all planning needed to fasten the seat belt (hand movements, how much force needed, coordination etc.). Over time, this becomes habitual, and you may sit in your car seat and automatically perform the action. From a behaviourists perspective, habits are formed and strengthened through the use of rewards, consistent with operant conditioning principles (Lally, Van Jaarsveld, Potts & Wardle, 2010). Therefore people are more likely to continue performing an action when the consequence of that action in the past has resulted in some kind of reward. For example, when eating cake results in pleasurable feelings, you are more likely to eat cake again.

Applying behavioural economics to understand habits

“

Nothing so needs reforming as other people's habits.

”

— Mark Twain

How do key behavioural economic concepts relate to understanding the habitual choices we make? Thaler, Sunstein and Balz (2010) explain that we are often forced to make decisions influenced by many noticeable and unnoticeable variables. We as humans live complex lives, so the development of habits make it easier for us to go about our day without taking the time and cognitive effort required to fully assess every situation with rational decision-making processes (Duhigg, 2012). This leads to a Habit Loop. The habit loop occurs when an environmental cue is introduced, this is followed by a certain behaviour, then the behaviour results in a reward (Duhigg, 2012). When the environmental cue is presented in a way that requires us to call upon additional information, we often create mental shortcuts by using the heuristics we talked about earlier. For example, when attending a lecture for the first time, you may consider all possible ways you can think of in your head to get to the lecture room. However, you know you once had a class close to this new lecture room, so you choose to take that familiar route and disregard other information that may get you to the room quicker (such as signs, or word of mouth). Over time, we become desensitized to the cue and automatically engage in the behaviour, thus creating a cognitively shorter route to the reward, known as a habit. Therefore, we take the same route to the lecture room each week without even thinking about it.

Applying behavioural economics to change habits

Now that we know the key concepts of behavioural economics and how habits develop, how can we put these two together and use this to alter habitual behaviour? The key step to change habits is by recognising the cues that instigate behaviour, and substituting this behaviour with a more desirable one (Duhigg, 2012). This is not always so straightforward, as we often need be aware of the underlying biases and variables that may be lurking in the decision-making processes that lead to a behavioural choice.

Smoking

Cigarette smoking is a popular yet highly addictive habit, despite the large number of health risks and anti-smoking campaigns (Gartner, Barendregt & Hall, 2009). Cigarettes contain nicotine, a substance that causes a release of dopamine making the individual feel a sense of pleasure (Jacobsen et al., 2008), thus leading to habit formation. However, at this moment in time the average smoker is aware of the dangers of cigarette smoking, so the rational decision would be to quit straight away. Yet, many of us still continue to smoke despite this.

Let us recall the theory of delay discounting, which explains that people are more likely choose a small reward that is delivered immediately over a large reward delivered after some delay. Delay discounting results in many people developing a smoking habit, despite not always being aware of it. Humans tend to value an immediate reward as higher than a future reward (Bickel & Marsch, 2001). From an evolutionary perspective, this can be understood in animals who have no reason to delay the intake of food presented to them, as it may not be available in the future. We as humans sometimes do this without automatic thought processes instructing us otherwise, therefore immediately consuming a product for its reward. Research has found that those with some sort of substance addiction (particularly nicotine) are less likely to delay immediate rewards, even when the delayed reward is larger (Bickel & Marsch, 2001). Therefore, we can see how smoking habits lead to the choice of the instant reward gained from cigarette over long term reward of better health outcomes.

Tips to avoid smoking habits:

Being aware of instant gratification effects, and consider the long-term benefits of not smoking at all, and really asses these.
Create a new behaviour and reward when you recognise the cue component of the habit loop, for example, going for a walk when you get cigarette cravings.
Create a consequence for the undesirable behaviour through the use of a contingency contract or online resources such as Beeminder

Eating

Have you ever noticed that everyday items such as bread and milk always seem to be located at the back of the store? This seems somewhat counter-intuitive at first, as surely there are so many customers who just want a quick trip inside to get these products and be on their way. So why not put the popular products at the front of the store? Supermarkets are aware of this, and use behavioural economics to maximise our consumption of their products. By placing items at the back, we are more likely be distracted by other items for sale as we walk through the isles, particularly items on sale.

How can we be aware of this, and improve our eating habits? Studies have shown that our emotions and availability of cognitive resources impact heavily on our food choices, and when to stop eating (Just, Mancino & Wansink, 2007). For example, a study from Shiv and Fedorikhin (1999, as cited in Just, Mancino & Wansink, 2007) found that when asked to choose between cake or salad while performing a cognitive task, most participants chose the cake, even when the cake price was considerable higher than the salad. It is thought that when we have numerous decisions to make, we rely on our heurstic judgements, even with food. These judgements are sometimes useful, and sometimes we are essentially persuaded by the marketing techniques of supermarket advertising as pointed out earlier.

Tips to avoid bad eating habits:

Try to write a shopping list when you go grocery shopping and stick to it to avoid impulse buys.
Try to grocery shop when you are not hungry, therefore less likely to be attracted to appealing foods.
If you are tempted by sale items off your shopping list write them down and come back to them later to assess whether you would have needed to purchase it if it was not on sale.

Overspending

Kahneman and Tversky (1979) explain that whenever we are uncertain about a product that we are looking to purchase we seek to find additional information that can aid in our decision-making process. This is where judgement errors can lead to inaccurate additional information.

Recall that anchoring and adjustment occurs when people focus too heavily on initial pieces on information. This strategy is used to the advantage of sales staff who initially quote a customer a price larger than the object's worth. For example, a sales assistant tells you a shirt is worth $50 and later follows this up by saying she is willing to sell the item for $45, despite the shirt's actual worth being lower. You are likely to focus on the initial value and see any lower price as a positive and any higher as a negative, and may disregard any contradictions to this. This tactic is particularly common in house and car sales. Being aware of judgment heuristics can be a key method in avoiding overspending habits. That is, not relying on "a gut feeling" when making purchases, and taking into account how we could be victim to errors in judgement such as this.

Tips to avoid bad purchasing habits:

Be aware of companies framing a value as cheaper due to smaller increments, for example, $84 per month for a year sounds cheaper than a $1000 payment.
Be aware of language aimed to bias our decisions, for example, "the cupcake will be $3 extra" versus "the cupcake is only an extra $3".
Be aware of anchoring products, for example, restaurants putting highly profitable items next to a expensive anchor can encourage us to think of the highly profitable item's price as more reasonable.

Procrastination

Procrastination is the delaying of tasks that need to be done but are considered undesirable (O'Donoghue & Rabin, 2001). It is assumed that most people procrastinate to some degree, although some of us do so more than others. Furthermore, we are more likely to procrastinate the more important we perceive the task to be. Economic research suggests one driving motive behind procrastination is choice. That is, choosing which task to complete and when to do it (O'Donoghue & Rabin, 2001).

Rationally, an individual would want to achieve the best possible outcome for herself and therefore put in all effort required from the start to successfully complete the task. However, if this is the case then why are many university students not motivated in this manner and leave things until the last minute? People often put off tasks that have an immediate cost but will be beneficial in the future, such as having to write a paper. This is also explained by delay discounting, this constant motivation towards immediate rewards, and lack of future considerations that leads us to procrastinate. The best way to change procrastination habits is to notice the cue and create a new reward. So when feeling distracted, perhaps choose a new place to study and plan to reward yourself with a snack after study.

Tips to avoid procrastinating:

Visualise the positive emotions that will come with the completion of the undesirable task.
Rather than have a focus on trying to eliminate the procrastination impulse, try to gain control though allowing periodic procrastination. An example when studying could be 45 minutes of focused study followed by 15 minutes of internet browsing.
The use of nudge motivation programs such as Stickk to reach a goal and be motivated to avoid punishments when the goal is not being reached.

Visit Psychology Today to take their interactive 30 minute procrastination test, and find out if you are prone to procrastination habits.

Criticisms

There are three main arguments that critics put forward when arguing against the theories of behavioural economics. First, some critics have suggested that behavioural economics is a not a theory, but simply just a mix of tools or ideas. This can be a potential problem with testing scientific validity and generalising to the average person (Camerer, Loewenstein & Rabin, 2011). Second, critics have stated that the study of behaviour should stay the domain of psychology and leave the study of consumption and markets to the discipline of economics (Camerer , Loewenstein & Rabin, 2011). Last, some have suggested that behavioural economics should not be a separate school of thought, but rather a simplified model to understand economic and behavioural anomalies. (Camerer, Loewenstein & Rabin, 2011).

Conclusion

Hopefully you now have an understanding of behavioural economics, a field that combines traditional economics and psychological principles to help explain the underlying motivation affecting our decision-making processes. This chapter has discussed the key behavioural economic concepts such as Kahneman's prospect theory, heuristics and cognitive biases. In the second part of this chapter we applied this knowledge in understanding how habits develop via the habit loop and how we can alter habits by recognising the biases and judgement errors that could occur during the cue stage of this loop.

The key message to take home from this chapter is that we are capable of changing our decision-making and subsequent habit formation by taking the time to acknowledge how we can be motivated by the above mentioned cognitive shortcuts. Let us finish by briefly revisiting our student in the opening chapter. It is clear now that she has developed an undesirable procrastination habit. You should now feel more confident in being able to apply what we know about behavioural economics and the habit loop to explain how she could be motivated to change this and develop better studying habits. As well as this, using your knowledge of behavioural economics to change habits in other areas of your life too.

“Your beliefs become your thoughts,
Your thoughts become your words,
Your words become your actions,
Your actions become your habits,
Your habits become your values,
Your values become your destiny.”

— Mahatma Gandhi

References

Becker, Gary S. 1962. Irrational behavior and economic theory. The Journal of Political Economy 70(1): 1–13.

Bickel, W. K., & Marsch, L. A. (2001). Toward a behavioral economic understanding of drug dependence: delay discounting processes. Addiction, 96(1), 73-86. doi: 10.1080/09652140020016978

Camerer, C. F., Loewenstein, G., & Rabin, M. (Eds.). (2011). Advances in behavioral economics. Princeton, US: Princeton University Press.

Duhigg, C. (2012). The power of habit: why we do what we do in life and business. Great Britain: Random House Digital Inc.

Field, M., Santarcangelo, M., Sumnall, H., Goudie, A., & Cole, J. (2006). Delay discounting and the behavioural economics of cigarette purchases in smokers: the effects of nicotine deprivation. Psychopharmacology, 186(2), 255-263.

Gartner, C. E., Barendregt, J. J., & Hall, W. D. (2009). Predicting the future prevalence of cigarette smoking in Australia: how low can we go and by when?. Tobacco control, 18(3), 183-189. doi:10.1136/tc.2008.027615

Haselton, M. G., Nettle, D., & Andrews, P. W. (2005). The evolution of cognitive bias. In D. M. Buss (Ed.), The Handbook of Evolutionary Psychology(pp. 724–746). Hoboken, NJ, US: John Wiley & Sons Inc.

Heap, S. P. H. (2013). What is the meaning of behavioural economics?. Cambridge Journal of Economics, 28, 457-467. doi:10.1093/cje/beh014 Jacobsen, L. K., Krystal, J. H., Mencl, W. E., Westerveld, M., Frost, S. J., & Pugh, K. R. (2005). Effects of smoking and smoking abstinence on cognition in adolescent tobacco smokers. Biological psychiatry, 57(1), 56-66. doi:10.1016/j.biopsych.2004.10.022

Just, D., Mancino, L., & Wansink, B. (2007). Could behavioral economics help improve diet quality for nutrition assistance program participants?. USDA-ERS Economic Research Report, (43).

Kahneman, D., & Tversky, A. (1972). Subjective probability: A judgment of representativeness. Cognitive psychology, 3(3), 430-454. doi:10.1016/0010-0285(72)90016-3

Kahneman, D., & Tversky, A. (1979). Prospect theory: An analysis of decision under risk. Econometrica: Journal of the Econometric Society, 47(2), 263-291.

Kahneman, D. (2012). The Human Side of Decision Making. Journal of Investment Consulting, 13 (1).

Lally, P., Van Jaarsveld, C. H., Potts, H. W., & Wardle, J. (2010). How are habits formed: Modelling habit formation in the real world. European Journal of Social Psychology, 40(6), 998-1009. doi:10.1002/ejsp.674

O'Donoghue, T., & Rabin, M. (2001). Choice and procrastination. The Quarterly Journal of Economics, 116(1), 121-160. doi:10.1162/003355301556365

Rabin, M. (1998). Psychology and economics. Journal of economic literature, 36(1), 11-46.

Staddon, J. E. R., & Cerutti, D. T. (2003). Operant conditioning. Annual review of psychology, 54, 115-144.

Stern, P. (2000). Toward a coherent theory of environmentally significant behavior. Journal of Social Issues, 56(3), 407–424.

Thaler, R., Sunstein, C., & Balz, J. (2010). Choice architecture. Chicago, US: University of Chicago. doi:10.2139/ssrn.1583509

Tversky, A., & Kahneman, D. (1973). Availability: A heuristic for judging frequency and probability. Cognitive psychology, 5(2), 207-232. doi:10.1016/0010-0285(73)90033-9

Tversky, A., & Kahneman, D. (1974). Judgment under uncertainty: Heuristics and biases. Science, 185(4), 1124-1131. doi: 10.1126/science.185.4157.1124