In this video we’ll look at how nudge theory and behavioural insights can be used to address
market failure and achieve a more efficient allocation of resources.
Behavioural insights examine why people make irrational decisions as opposed to acting
like rational economic agents.
Nudge theory includes attempts to influence how individuals make decisions, not by restricting
them as such, but by presenting them with choices in a different manner.
Another way to think about this is that rather than dictating what consumers should do, a
nudge tries to push them in the right direction.
The method by which choices are offered is called ‘choice architecture’.
These nudges attempt to reduce the market failures associated with under or overconsumption.
In the following slides we’ll see how consumers may benefit from being nudged in a specific
direction.
To encourage people to save more for their retirement, employees should be automatically
enrolled into pension plans.
They are still allowed to opt out.
However, by having them choose to opt out, as opposed to opt in, consumers are more likely
to take part in the plan.
Research supports the claim that people are influenced by ‘default bias’ and will
stick with whatever choice is initially made for them.
In this case, if they are put into a savings plan by default, they may avoid opting out.
Likewise, if they are asked to opt into a plan, they are less likely to partake in one.
According to research completed by Vanguard, one of the world’s largest investment companies,
retirement plans that automatically enroll new workers have a 93% participation rate
vs. 47% of those with voluntary enrolment.
This is a clear indicator of the merits of such a policy.
To encourage healthy eating, the government may provide nudges towards making better dietary
choices.
Let’s look at the case of school cafeterias in which students are paying for their own
lunch.
A school cafeteria may place fruits and vegetables in areas of heavier foot traffic to encourage
their consumption.
By locating the salad bar in a high visibility and high traffic area it may encourage students
to opt for more salads in their lunch choices.
Utilities are the basic necessities for living a comfortable daily life.
They include water, gas, electricity amongst others.
The average consumer in the UK and likely elsewhere does not frequently change utility
providers.
This often results in consumers paying more for utilities than they possible could.
OFGEM, an electricity and natural gas regulator in the UK, sent letters to customers to nudge
them towards cheaper options.
Called the cheaper market offers letter, it was successful in converting some customers
and arguably more successful than efforts that did not include a direct letter.
Considered a demerit good, the government would want to discourage people from smoking
cigarettes.
In some countries, governments have required that cigarette packs have pictures on them
aimed at deterring smokers.
Alcohol is also considered a demerit good and the government may want to nudge people
towards consuming less alcohol.
One way that has been trialed is by sending people text messages that compare their level
of drinking to the average.
A significant number of heavy drinkers underestimate the amount they drink and this nudge could
discourage them from consuming as much.
As with any economic policy, nudges do receive some criticism.
Firstly, some view these policies as paternalistic.
They believe that the government is determining what is best for us and then trying to guide
us in that direction.
Critics argue that the individual should have more freedom in determining their choices.
Second, nudges may be of limited effectiveness.
Consider the case of images on cigarette packs of the harmful damage done by smoking.
Addicted smokers are unlikely to be put off by such images.
Thirdly, as with all government policies, there are administrative costs to operating
such schemes.
These are incurred in researching, developing and enacting policy.
Finally, these policies are not standalone solutions.
They work best alongside a combination of other policies.
In the case of preventing young people from smoking, it could entail a combination of
nudges, education and also the setting of a legal minimum age for purchasing.
This combination would be far more effective than any of these policies alone.
You should now have an understanding of how nudge theory can be used to address market
failure.
As always, leave any questions or comments below and I’ll do my best to answer them.