The Three Factors Shaping Decision-Making
When people ask us what Behavioral Economics is, we often briefly reply with, it’s a way of understand how humans make (often irrational) decisions. However, learning behavioral economics and applying it can be difficult for folks who are new to the discipline. Behavioral economics has faced some limitations due to its lack of systematization and organization. And without a cohesive framework we are left to memorize many different and separate theories one by one. We introduce a new approach that categorizes these theories into three distinct factors for practitioners, enabling a better understanding of the human decision-making processes which in turn allows us to more effectively apply them.
Factor 1: Decision Style
Decision styles play a critical role in how we process information and make choices as a result. One well-known dual processing theory is System 1 and System 2. To put it simply, System 1 is largely driven by intuition and System 2 is mostly reliant on logic. Depending on the situation, the brain uses either system to make decisions quickly and automatically or to make decisions by carefully analyzing all available information.
While System 1's rapid processing is valuable in making quick decisions and preventing cognitive overload, it can lead to overly simplified and potentially suboptimal decisions. Understanding the existence of both systems and employing each way of thinking appropriately is crucial for making better choices.
Factor 2: Context
In addition to decision styles, external circumstances also significantly impact human decision-making. People often make choices that are influenced by their environment, as opposed to the traditional belief of making rational decisions regardless of the context we’re in. For example, people make different decisions when they are with their coworkers or with their family, or if they are by themselves. People also make different decisions based on how our environment is laid out. One experiment has shown that people purchase more French wine than German wine when there is French background music playing in the store. Another has shown that people opt to purchase more expensive products when there are other people around.
While we want to think we are making our own decisions but often time, the context we’re in might mostly make decisions for us. Understanding how context influences our decisions can help us mitigate the effect when necessary, and create environments that lead to behavior we desire.
Factor 3: Emotion
Contrary to the assumptions of traditional economics, emotions can heavily influence human behavior and decision-making. Our choices are subject to change based on our emotional state at any given moment. Understanding how emotions influence our decisions can provide perspectives on how emotions are affecting your and others’ behavior, and also help manage your emotions in positive ways.
Evolutionarily, our emotions were meant to convey information to us. Fear may signal that we might be in danger, which helps us to take action quickly. As we evolved, we are left with useful emotions and some not so helpful emotions that might hinder our ability to act “rationally”. We can use these useful emotions to better ourselves and create positive change. On the other hand, we can learn to be aware and leverage the less helpful emotions to our advantage to better our lives and move our businesses forward.
The three factors working together:
As you may have already predicted, these three factors do not work in isolation; they are intricately intertwined and affect one another. In most cases, they work together, with one factor outweighing the others depending on the situation. Acknowledging these connections gives us a more comprehensive understanding of human behavior and the knowledge to identify which factors may be more at play during certain times.
By systematically organizing behavioral economic theories into decision styles, context, and emotion, we can achieve a more accessible approach to understanding human decision-making processes. Furthermore, with this structured approach, applying the insights from behavioral economics will be even easier. If you’d like to continue building your knowledge on these three factors, consider following the blog and subscribing for future updates!