It’s awards season!

Before you get too excited about couture dresses, the red carpet and celebrities’ speeches being cut off by orchestral music, let me explain. The Royal Swedish Academy of Sciences recently awarded the Nobel Prize in Economic Sciences to Richard Thaler, an economist at the University of Chicago, whose work in behavioral economics has revolutionized the way economists analyze the world.

To understand Thaler’s contribution to the field, we first need to have a brief lesson in economic theory (I promise that it won’t be too boring). Classical economics is based on the idea that people act in their rational self-interest, meaning that they do what is best for them at the time. While it’s obvious that this assumption is not true for every decision that a person makes 100 percent of the time, when looking at the big picture, it works well: an individual smoker may have continued the habit after research was published about the dangers of smoking, but overall, rates declined.

Thaler, on the other hand, calls this assumption into question. In his 1980 publication “Toward a Positive Theory of Consumer Choice,” Thaler contends that people act irrationally (in the economic sense of the word) in consistent ways:

  1. They “under-weigh opportunity costs,” or they place more value on things they have currently than things they don’t have, even if the price tag for the two items is the same. For example, let’s pretend that you paid $250 for a plane ticket to go on vacation. However, once you’ve boarded, you find out that the flight is overbooked, and the airline offers a $300 voucher for giving up your seat. Classical economics would suggest that you would be better off taking the $300 voucher (all other things equal), but would you? Or would you value the $250 seat that you currently have now more?
  2. They fail to treat “sunk costs” (things you paid for in the past) as sunk, or as irrelevant to current decisions. For example, if someone goes to brunch that includes bottomless mimosas, classical economic theory would suggest that she would stop ordering and consuming mimosas when she decided she had had enough, even though it is the same price if she has one or three. However, would she in reality?
  3. They do not ascribe to “rational” search behavior. Let’s say that you want to top off your gas tank. You can either pay $2.50 per gallon at the station closest to you, or you can make a left U-turn across multiple lanes of traffic to pay $2.45 per gallon somewhere else. Classical economic theory would predict that you would not drive for the cheaper gas—after all, you’d be saving maybe $0.50, and there would be the added traffic hassle (and gas consumption) to get to the other station. But would you go for the lower price because it’s cheaper?
  4. They “choose not to choose” in situations that could make them happier because they don’t want to experience regret. For example, let’s say that you are a regular at a local restaurant and always order the same meal. During one visit, you decide that the special sounds more appealing to you than your usual order does. Do you order what sounds best (as classical economics would suggest), or do you stick to what you know that you like so that you don’t possibly regret your decision?
  5. They may require assistance with “precommitment” and self-control. Pretend that you are working on a research assignment that requires you to use the internet, and after a while, you find yourself on your preferred social media website instead. Classical economics would suggest that being compensated for the research (either with a grade or with a paycheck) should be sufficient to make you prioritize the task over being on social media. However, would you be able to do this, or would you need to have a friend change your social media password until the task was completed?

Taken together, these examples show how people often don’t behave within the confines of classical economics. Thaler’s later work further has expanded upon people’s lack of self-control and their preferences toward what is fair, even if it is irrational or inefficient. In addition to his contributions to academia, Thaler has written books for the lay audience, including Nudge, which explores how behavioral economics research can be applied in the real world by “nudging” people to make good choices: for example having fruit instead of candy bars at the cash registers of cafeterias increases fruit consumption. More recently, Thaler published Misbehaving, a history of behavioral economics.

The impacts of behavioral economics have been vast in both the real world and the academy. While Thaler’s work has been controversial in the economics community for some time, receiving the Nobel Prize recognizes Dr. Thaler for his significant contributions to the field. Thaler’s work has made Econs (his name for those with training in economics) question their fundamental assumptions of rational behavior, and the field of behavioral economics has piqued interest in these “‘radical” notions.