What is cognitive bias and how does it impact decision making?
Cognitive bias is a process, where people do not take any decision rationally. Thus, people take their quick decision, based on their choice. Consequently, this systematic pattern of thinking may bring inaccurate judgment, perceptual distortion and illogical interpretation (Boukhechba et al. 2018). This type of biasness can be found in various grounds, for instance, political, economical and social one, where people take their decision from their own perspectives, without considering any judgment. Hence, this report has intended to analyze some real-world situations, where cognitive biases can be seen in various form, like, bandwagon effect, anchoring, decoy effect and so on. Moreover, the problem of biasness can also be found within the behavioral economics.
In real world, people have possessed various notions, which they follow without any judgment. For instance, society influences an individual to take a bias decision for a particular product. This can be explained with the help of real world case. People have adopted fast foods as necessary goods within their daily life and this in turn has helped those companies to expand their business. However, not all people, especially, children consume fast foods because of their busy schedule. Rather, most of them consume these products as other some people have consumed those and have provided good feedbacks regarding tastes, quality and quantity (Rohaut and Claassen 2018). In the context, preference has also played an important role. Fast food industry is expanding significantly with large number of companies, providing same kind of foods. However, to differentiate with each other, they use their own tag line during advertisement to attract customers. Those tag lines sometimes influence people positively and consequently, some people have started to prefer a particular fast food company without considering the products and quality of others. Thus, without judging prices, qualities and quantities of other companies, people have behaved irrationally (Scott, Soon, Elshaug and Lindner 2017). Hence, within this situation, two types of cognitive effects can be observed. The first one can be referred as the Bandwagon effect, where people are blindly following choices of others within a society without considering their own needs or negative impacts of fast foods on health. The second situation can be described as framing effect.
Nudge:
Cognitive effects lead people towards the negative direction while nudge helps them to take the correct decisions. Hence, through construct proper nudges, negative impacts of cognitive biases can be controlled. Therefore, this concept is also applicable for the above-mentioned situation to reduce the increasing rate of fast food consumptions among people (Zwaan et al. 2017). For this, the local government or the state government can increase tax rate on fast foods and this in turn has forced the prices of those products to increase further. On the other side, tax rate on healthy foods can be reduced for which prices can also be reduced further (Hansen 2016). Therefore, according to the demand law, increase in price of fast foods can lead the demand for those products to decrease further while decrease in price of healthy foods can increase their demand. In addition to this, the government can organize health campaigns among various schools and colleges (Wang, Liaukonyte and Kaiser 2018). Through these campaigns, doctors can provide awareness among those children regarding the negative impacts of fast foods on health and its future consequence. Moreover, school authority can provide healthy and tasty foods to their children through school canteen.
Real world situations where cognitive biases can be observed
Cognitive bias can also be seen within the labor market. In real world, the number of unemployment is increasing significantly and consequently, most of them are trying to get a job with comparatively lower prices. However, they may have different preferences for different companies. This can be referred as anchoring, where workers have taken their decision based on small information. For different companies, the rules and regulations are different for workers. Some companies have provided more benefits along with higher wages compare to others. However, based on small information, workers can select those companies, which have offered small amount of wages with lower facilities. Hence, in this context, the person has behaved irrationally.
Concept of classical economists:
Cognitive bias may not found within the classical economics as it has considered people as rational. Moreover, each people are employed with existing market wage for which unemployment cannot be found within this system (Bresser-Pereira 2018). This can be expressed with the help of a diagram.
Figure 1: Full employment under classical economy
Source: (created by author)
In figure 1, the demand and supply curve of labor has been drawn. The X-axis has measured total amount of full employment while the Y-axis has measured real wage, that is, W/P. here, W refers as nominal income and P refers the price level. Under classical economy, the real wage rate is assumed as flexible. Hence, the labor market has always remained at a stable position (Stiglitz 2015). However, under real scenario, wage rate for all firms are not equal. Moreover, due to cognitive bias, labor can choose a firm, which has offered lower wage rate. Thus, in this context, wage rate fluctuation is not required. Thus, classical economists have not addressed this problem.
Concept of behavioral economics:
Behavioral economics has influenced the social, psychological, emotional and cognitive factors for taking proper economical decisions regarding a firm or an individual (Frederiks, Stenner and Hobman 2015). Hence, within this labor market, behavioral economics can consider various micro economical factors that can influence them to take proper decision. For instance, firms, which have lower demand in market, can offer various training courses for their workers for making them more efficient (Hanushek, Schwerdt, Woessmann and Zhang 2017). In addition to this, they can provide subsidies, rewards and other facilities to their workers. This in turn can influence workers to change their biasness. As psychology plays an important part, it is essential to understand the basic requirement of a labor. In this contest, it can be mentioned that the chief factor, which attract a labor more, is higher amount of wage with strong labor union. A strong labor union can improve the condition of workers within a company. Hence, this support can further influence labors to work within this company.
How proper nudges can control cognitive biases to reduce negative impacts
Figure 2: Wage Floor by trade union
Source: (created by author)
Figure 2 has represented the impact of trade union within the labor market. In this figure, the demand and supply curve of labor has been drawn. Through equating these two curves, equilibrium amount of wage has been determined. However, due to the presence of trade union, the firm needs to pay W1 amount of wage, which is higher compare to the W0. Hence, from this context, it can be said that the behavioral economics have helped labor market to earn higher amount of wage.
Conclusion:
In conclusion, it can be stated that through cognitive bias, people have taken irrational decisions. This biasness can be seen in real world, where people take their decision based on some factors that can motivate them mentally. Hence, here the concept of psychology is very important. People can be influenced through their society or minimum information from others. in this context, by taking proper nudges, this biasness can be changed. In this context, it can be mentioned that under classical economics, the concept of cognitive bias cannot be found, as those economists have considered human-being as rational.
References:
Boukhechba, M., Gong, J., Kowsari, K., Ameko, M.K., Fua, K., Chow, P.I., Huang, Y., Teachman, B.A. and Barnes, L.E., 2018, March. Physiological Changes over the Course of Cognitive Bias Modification for Social Anxiety. In Biomedical & Health Informatics (BHI), 2018 IEEE EMBS International Conference on (pp. 422-425). IEEE.
Bresser-Pereira, L.C., 2018. Growth and distribution: a revised classical model. Brazilian Journal of Political Economy, 38(1).
Frederiks, E.R., Stenner, K. and Hobman, E.V., 2015. Household energy use: Applying behavioural economics to understand consumer decision-making and behaviour. Renewable and Sustainable Energy Reviews, 41, pp.1385-1394.
Hansen, P.G., 2016. The definition of nudge and libertarian paternalism: Does the hand fit the glove?. European Journal of Risk Regulation, 7(1), pp.155-174.
Hanushek, E.A., Schwerdt, G., Woessmann, L. and Zhang, L., 2017. General education, vocational education, and labor-market outcomes over the lifecycle. Journal of Human Resources, 52(1), pp.48-87.
Rohaut, B. and Claassen, J., 2018. Decision making in perceived devastating brain injury: a call to explore the impact of cognitive biases. British Journal of Anaesthesia, 120(1), pp.5-9.
Scott, I.A., Soon, J., Elshaug, A.G. and Lindner, R., 2017. Countering cognitive biases in minimising low value care. Med J Aust, 206(9), pp.407-411.
Stiglitz, J.E., 2015. Reconstructing macroeconomic theory to manage economic policy. In Fruitful Economics (pp. 20-56). Palgrave Macmillan, London.
Wang, R., Liaukonyte, J. and Kaiser, H.M., 2018. Does Advertising Content Matter? Impacts of Healthy Eating and Anti-Obesity Advertising on Willingness to Pay by Consumer Body Mass Index. Agricultural and Resource Economics Review, pp.1-31.
Zwaan, L., Monteiro, S., Sherbino, J., Ilgen, J., Howey, B. and Norman, G., 2017. Is bias in the eye of the beholder? A vignette study to assess recognition of cognitive biases in clinical case workups. BMJ Qual Saf, 26(2), pp.104-110.
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