How many times have you actually bothered to untick the option of adding insurance to your air tickets while booking your flight? And how many times have you selected the option of adding insurance to the air tickets yourself? According to a recent study, the number of people opting for insurance for their air tickets has increased by more than twice ever since it became a default option. They are being automatically enrolled for the insurance policies which has become an opt-out instead of an opt-in. It was just a slight “nudge” which made the difference.
What exactly is a nudge? A Nudge is a gentle indication to a consumer which pushes her to choose a particular option. They are gentle and easy to execute, and they cannot block off all the other options. Therefore, the goal is to promote a consumer to take the option you want him to take and get the traffic moving in the right direction. At the same time, it ensures that the other options are not eliminated altogether.
Mainstream economics has been using a number of assumptions which serve as a benchmark to predict behaviour. However, we are far away from the reality when we study these concepts. This is because mainstream economics assumes the concept of an ‘economic man’. An economic man always takes actions to maximise his long-term best interest, has stable preferences and is a consistent rational actor. However, the truth is that these traditional economic assumptions prove ineffective in the real world. On the other hand, behavioural economics focuses on the limitations of human rationality. It identifies humans as homo sapiens and not homo economicus. This branch of economics is heavily based and informed by literature in psychology and neuroscience.
Prof. Richard Thaler believes that nuanced changes in the “choice architecture” can result in desired changes in the behaviour of humans. “Choice architecture” signifies the different designs in which choices are presented to the consumers.
The ’nudge theory’ has wide implications in diverse fields and has been welcomed by a number of policy-making bodies including the UN and World Bank. Thus, nudging has emerged as an avant-garde appetite for low-cost solutions for the policy-making bodies. It offers an easy way out to reform society without taking the help of large spending programmes. It exploits human weaknesses for human benefit. For example, cigarette packets mentioning ‘Smoking is Injurious to Health’ is nothing but a nudge to ensure that the consumers take steps for the benefit of the society. India has also set up a Nudge Unit under NITI Aayog. This unit has been working on a number of policies including increasing the turnout during elections, efficient cleanliness drive under Swachha Bharat Abhiyan and better compliance with traffic regulations.
Nudge is not limited to policy-making bodies but has gone rampant in the marketplace as well. In fact, the “To Do Reminder” applications on our phone is nothing but a nudge. How many times do we find an Uber message on our phone encouraging us to use the UberPool cars instead of booking a private one for ourselves? Well, this again is a nudge which is being used by the businesses to not only protect the environment but at the same time maximizing profits. Do note that in the above cases no one is being deprived of freedom. People still have the liberty to decide for themselves. However, they are being influenced to opt for a choice that is desirable for society.
Let us now discuss how humans deviate from rationality and how they are guided by ideas of behavioural economics:
A number of times we see that the most optimal choice we make at one point of time no longer remains an optimal choice at another point in time. Thus our “rationality” is not constant and differs from time to time depending on the situation. This is called Time-Inconsistent Preferences. To cite an example with which each one of us can relate, let us consider this situation:
When a Mathematics teacher was deciding upon the date of the examination, she had put forward two options in front of the students. Option 1 was to sit for the examination after 25 days without sacrificing a chocolate. The next was to sit for the examination after 26 days but whoever chose this option would have to pay a fine of 2 chocolates. It was seen that most of the students opted for Option 1 in the above case as they were not willing to sacrifice a couple of chocolates for an extension of a day. However, when the same was offered to the students a day before the examination, most of them were ready to sacrifice their chocolates for a day’s extension.
This example questions the rationality of “economic humans” while making decisions. A study of human behaviour shows that people prefer immediate gratification over long-term welfare. This leads to preference reversal, a very famous example of which is hyperbolic discounting. People are being offered a nudge by being asked to buy now and pay later. This ‘nudge’, offered by companies like Amazon, has been responsible for the increased sales of mobile phone companies by a huge margin.
Status quo bias, which is another deviation from rationality, is very evidently seen a number of times in our lives when people prefer things to stay the same even if negligible transition cost is involved and the decision is very important. In fact, the status quo bias is believed to be one of the reasons due to which Section 377 had been in our Penal Code for many decades. This is how the graph of the Status Quo Bias looks:
In the above graph, we can clearly see that the curve increases at an increasing rate in the 3rd quadrant whereas it increases at a decreasing rate in the 1st quadrant, such that the value of | y | when the curve lies in the 3rd quadrant surpasses the value of | y | when the curve lies in the 1st quadrant, for any given value of x. In the above graph, we see that when x is -100, the value of | y | is more than the value of | y | when x = 100. This is a demonstration of the Status quo bias humans demonstrate wherein they prefer to stay in the 3rd quadrant ( i.e. continue with the existing status without taking any initiative.) Now let me explain this concept with the scrapping of Section 377. Though there was always a need to bring about this change in policy, there was a lack of initiative taken by the citizens due to inertia. It was only after the recent upsurge of the people against this policy that the shackles of Status Quo bias was broken and people started to demand a change in the policy. Thus there emerged a Delta Y in the first quadrant such that the value of | y | in the first quadrant became more than the value of | y | in the 3rd quadrant. This is how people managed to move out of the status quo bias.
One of the nudges used by the restaurants with respect to this inertia of the consumers is keeping a bottle of mineral water on the table even before the consumer asks for it. It was seen that the consumers in the budget restaurants mostly asked for house water and very few of them actually asked for mineral water. However, when the restaurants started placing the bottles of mineral water on the table before the consumers asked for it, a large number of consumers (due to the status quo bias and inertia) consumed the mineral water instead of going out of the way and asking the waiter to replace it with regular drinking water.
Framing effect is a type of cognitive bias wherein the decision a person takes is largely affected by the way the information is presented. It is, therefore, a representation of the same information in alternative ways such that it significantly alters the ultimate decision of the consumer. This is because, in the end, it is not what you say but how you say. Phrasing information mildly is considered to be a very important part of marketing by companies like Apple today.
Bounded Rationality is another concept in Behavioural Economics which says that when an individual makes a decision, his/her rationality is limited by the tractability of the decision problem, the cognitive limitations of their minds and the finite amount of time they have for the decision to be made. Thus, according to this concept, any individual who intends to make rational choices is bound by making satisficing, instead of optimal, choices in complex situations.
However, nudge is not always good. They sometimes manipulate the consumers and are used by people for their personal gain. One example of this was seen in the mortgage industry in the early 2000s. A number of schemes were introduced and the borrowers were being encouraged to take loans which they eventually would not be able to pay after the real estate prices fell. Thus, they were being nudged to take more loans and invest in the real estate market. Competition did not eliminate this practice, because it was hard for anyone to make money selling the advice, “Don’t take that loan!”. The nudge theory has also faced a lot of criticism as it psychologically manipulates the voters instead of providing them with proper education about choices.
As customers, we can minimize the negative effects of a nudge by properly scrutinizing questionable offers like trip insurance and free one month trials. We should remember that nudge can be God or Devil, depending on how it is used.
According to Professor Richard Thaler, three principles should guide the use of Nudge. Firstly, there should be a certain degree of transparency in order to ensure that nudge is not misleading. Secondly, there should be a fair and easy opt out of the nudge. This is because the objective of a nudge is to encourage a particular choice but at the same time give the consumers freedom of choice. Lastly, Professor Thaler believes that his theory should only be used for the welfare of the society which is one of the main reasons why he named his book, “ Nudge: Improving Decisions about Health, Wealth and Happiness.”
However, nudge does not turn out to be a miracle cure for all the challenges faced by the Governments and the businesses. This is because some problems are too big to be cured with a ‘slight push’. Some of them need a ‘shove’.
By Akul Parasrampuria.