Richard H. Thaler and "Nudge" Theory

Richard H. Thaler and "Nudge" Theory

October 9, 2017

Richard H. Thaler has been awarded the 2017 Nobel Prize of Economics for his work in uncovering the role that behavioral economics plays in today’s economy. Richard Thaler is also known for being a pioneer of “nudge” theory.

Nudge theory proposes the use of positive reinforcements and suggestion to influence one’s decision making processes. Many also consider the theory to be as effective – if not more- than direct instruction and legislation. “Nudges” are small alterations to the environment’s choice architecture that prompts a directed decision. One such example is the addition of a miniature soccer goal and ball to urinals in public toilets, which has proven to improve the cleanliness.A more general example is presented by Richard Thaler and Cass Sunstein in their book Nudge: Improving Decisions About Health, Wealth, and Happiness :

“To count as a mere nudge, the intervention must be easy and cheap to avoid. Nudges are not mandates. Putting fruit at eye level counts as a nudge. Banning junk food does not."

However, nudges are able to influence us on a much broader, economic scale. The early 2000s real-estate market was characterized by the use of nudges in mortgage deals. Consumers were provided initial discounted mortgage incentives that made it very easily to open a mortgage, but very difficult to maintain after it's introductory offer due to high interest rates. This contributed greatly to the credit crunch that afflicted many U.S. consumers. Another very popular nudge used by many publications involved having the customer input their billing details in order to gain access to a free trial or membership. Many customers forget to cancel their subscriptions end up paying for at least a month.

Nudges help economists understand that consumers are predisposed more towards short-term gains when it comes to decision making. The phenomenon further lends itself towards the fact that traditional economic models are becoming less reliable, while the study of behavioral economics becomes invaluable.

Behavioral economics and nudges practically govern the world's stock markets. While fundamental analysis gives an investor and appropriate measure of a company's general performance, the company shares may not be priced rationally. Expectations, cognitive errors, information deficits, heuristics, and biases contribute to the pricing of various assets. Nudges are an integral part of trading; they can and are used for individual profits whether by financial advisers, or by malicious fund managers such as Bernie Madoff. With an understanding of behavioral economics one can circumvent irregularities in inefficient markets and recognize patterns that TA can help distinguish. Thaler's work is a testament of consumer irrationality and tendency in underweighting base rates and overweighting new information: the final stray from the homoeconimus ideal of classical economic theory.

American Economic Review 2008, 98:1, 38–71