Updated: Nov 30 2006, 05:30am hrs
Behavioural economics, which uses interdisciplinary insights to understand human behaviour, is currently a glamorous discipline. The insights from this frontline area represent a sharp departure from the model of homo economicus as a rational tool towards understanding irrationality and quirkiness in behaviour. Daniel Kahneman of Princeton University and Vernon Smith of George Mason University were awarded the Nobel Prize in 2002 for pioneering the use of psychology and experimental economics to better understand decision-making under uncertainty. Eldar Shafir, a professor of psychology and public affairs at Princeton seeks to incorporate street psychology into economics, according to a recent feature on his work in the Princeton Weekly Bulletin. One area of his research is to figure out the circumstances under which lower-income individuals make financial decisions. He observes that in poor neighbourhoods in Philadelphia and New Jersey, many prefer to cash their chequesnot in banks, which they find intimidating and unwelcome, but in various cashing services at a higher rate just because the clerk remembers their mothers name. This sort of quirky behaviour goes against the grain of conventional economics that assumes rationality on the part of consumers who are impervious to psychological factors. Shafirs experimental studies focus, in particular, on how minor contextual nuances alter those financial decisions by poor households. One of his field experiments was in South Africa and led to a working paper for the National Bureau of Economics Research, entitled Whats Psychology Worth A Field Experiment in the Consumer Credit Market. With a banks cooperation, loan offers were mailed to 53,194 former clients that differed in interest rate and monthly repayments. For some, the letter presented only a single example of repayment for a given loan maturity and size while for others it presented examples of repayment under multiple possible terms and sizes. These letters also experimented with the addition of photographs to the loan offer letter, because psychology has found that visual cues can influence behaviour. Consistent with conventional economics, the results of their experiment show that interest rates significantly affected loan take up. But inconsistent with conventional economics, psychological manipulation also affected loan take up. More simplicity in the description of the loan offer increased take-up when compared with letter offers that gave multiple optionsconsistent with behavioural research that suggests that proliferation of alternatives is often detrimental to choice. Such behavioural research does have relevance for the design of micro-finance in countries like India.