Behavioural Economics: Understanding Rules of Thumb

Rules of Thumb – a cornerstone of behavioural economics. Discover how these mental shortcuts simplify decision-making, conserve cognitive effort, and help us navigate complex choices.

Definition and Role:In behavioural economics, "rules of thumb" refer to heuristic strategies or mental shortcuts that individuals use to simplify decision-making. These approximate methods help manage complexity and uncertainty, bypassing formal, logical procedures.

Reasons for Use:

1. Cognitive Efficiency: Conserves mental effort when faced with large amounts of complex information.
2. Speed: Enables quick, actionable decisions in time-sensitive situations.
3. Limited Rationality: Reflects bounded rationality, where individuals use shortcuts due to cognitive and informational constraints.

Examples:

• Equal Allocation Heuristic: Distributing resources equally across options, such as splitting investments evenly among funds, can often rival the performance of complex algorithms.
• Take-the-Best Heuristic: Prioritizing a single criterion (e.g., test scores) while ignoring others for decisions like school selection.
• Social Circle Heuristic: Relying on personal recommendations for choices such as selecting a doctor.

Rationality of Heuristics:While heuristics may lead to biases or errors in some contexts, they are often rational given the constraints of time, information, and cognitive capacity. They strike a balance between accuracy and effort, performing well in familiar or predictable environments but may cause systematic errors in less suitable conditions.

These insights are central to understanding decision-making processes in behavioural economics.