The Cognitive Bias Concept In “A” Level H2 Economics Exam (9570).

In my previous article, I had mentioned that there are new syllabus requirements for “A” Level H2 Economics from 2023, and I expanded in detail the addition of “non-rejectability” as a characteristic to public goods.

In addition to that, the latest SEAB syllabus requirement further states that:

• An awareness that firms may apply knowledge of consumers’ cognitive biases (sunk cost fallacy, loss aversion or salience bias) in their strategies is required; and
• An awareness that governments may apply knowledge of cognitive biases (sunk cost fallacy, loss aversion or salience bias) to nudge the decisions of economic agents is required.

As to be expected of new introductions to any syllabus, not much material is available as yet beyond schools’ notes about this, so my students have been confused about the application of such concepts to their essays and case studies.

The following discussion aims to plug this gap, by discussing the practical aspects to applying cognitive bias in the exams.

Who is Homo economicus?

The typical start-point for the Economics padawan frequently involves the assertion that the human subjects are rational beings, a.k.a Homo economicus (the Economic Man).

There arises a need therefore, to explain that Homo economicus is the model human whose behaviour always reflects:

• Self-interest: Benefiting self is the sole end to all means;
• Rationality: Decision-making that maximises self-interest; and
• Perfect access to information:  Perfect knowledge of all prevailing information required for any economic decision.

Of course such behaviours are unrealistic and even Economists have known that for the longest time, although this hadn’t stopped the continued exploitation of this make-believe model human.

Simply put, the cessation of use of Homo economicus would have rendered unacceptable, the reasonable use of almost all Micro-Economics’ framework, and this wouldn’t help the cause of making students take Economics as a subject.

There are several reasons to the almost-scandalous fallaciousness of Homo economicus including:

• Humans clearly having motivations beyond self-interest;
• The diversity in individuals’ behavioural quirks;
• The lack of perfect information access; and of course
• Cognitive bias.

It is of particular interest to the latter that SEAB has taken explicit interest in, and so we must too for the ensuing discussion.

What is Cognitive Bias?

In the context of Economics, cognitive bias refers to systematic patterns in thought processes that can affect the decisions and judgments made by individuals. These can arise from a variety of sources, such as personal experiences, preconceptions, emotions, and social influences.

Less “beat-around-the-bush” definitions would consider cognitive bias to be systemic errors in judgement, with the deviation in behaviour being measured against self-interested benefits-maxmisation.

Sunk Cost Fallacy.

The sunk cost fallacy is a cognitive bias that occurs when individuals continue to engage in a certain endeavour because of time, effort, or money invested into it, even if it may no longer be in his/her best interests.

Strategies for firms and governments relating to the sunk cost fallacy focuses on inducing initial investments from the target to “lock in” further future commitments.

Some examples of how firms may apply knowledge of consumers’ sunk cost fallacy include:

• Offering a free trial period. Consumers may be reluctant to cancel the subscription after the trial period is over, even if they are not using the product. This is because the consumers will feel like they have already invested time and effort into learning how to use the product, and they will not want to waste that investment.
• Selling a product with a high upfront cost. Consumers may be reluctant to stop using the product, even if there are other substitutes. This is because the consumers will feel like they have already invested a lot of money into the product, and they will not want to lose that investment.

And some examples of how governments may utilise economic agents’ sunk cost bias to nudge for desirable behaviour include:

1. Incentivising economic agents. Certain activities such as hosting foreign business activities require upfront investments, whichh the government can offer one-off tax breaks or subsidies. Once such investments are made, companies may become less inclined to shift out despite business climate changes.
2. Encouraging ownership over leasing/renting. Economic policies encouraging ownership and the necessary investments in cost and effort on procuring and prepping of spaces, may induce sustained internalisation of the previously externalised costs and benefits.

Loss Aversion.

Loss aversion is a cognitive bias where for the same amount of objective gain or less, individuals feel a greater sense of loss than the sense of gain.

Strategies for firms and governments relating to loss aversion focuses on maximising perceived benefits and minimising perceived loss felt by the target specific to the action.

Examples of firms’ strategies relating to loss aversion in consumers include:

1. Using scarcity. Firms may offer a product for a limited time or in limited quantities, creating a sense of FOMO (fear of missing out), which can induce consumers to purchase the product, even if they don’t really need it.
2. Using social proof. Firms may show testimonials from satisfied customers or display positive reviews on its website. This may reduce the fear of loss, as consumers may internalise others’ positive experiences with the product or service.

Examples of governments’ strategies relating to the use of loss aversion to nudge economic agents’ decisions include:

1. Using default options. Governments may use utilise default options for choices that involve perceived loss to individuals, such that they will not need to make such considerations ordinarily, increasing the likelihood of buy-in for potentially unpopular policies such voluntary retirement savings or organ transplants.
2. Using framing effects. Framing arguments for potentially unpopular policies such that the perceived loss to individuals are minimised, whilst maximising perceived gains, is a common tactic to gain buy-in and induce desirable behavioural changes from economic agents.

Salience Bias.

Salience bias is a cognitive bias that describes our tendency to focus on information that is more prominent or noticeable to us, when making decisions.

Strategies for firms and governments relating to salience bias therefore focuses on making obvious as much as possible key information that positively influences decisions by the target towards the desired outcomes, and minimising the target’s exposure to dissenting information.

Broadly speaking, with the exception of use of coercion, both firms and governments and utilise similar salience bias strategies to influence desired outcomes in consumers and economic agents respectively:

Examples of firms’ and governments’ strategies relating to salience bias include:

1. Using eye-catching visuals. People tend to be influenced by visual stimuli, so firms and governments frequently use eye-catching visuals to attract attention to information that are relevant to the product or service advertised.
2. Using emotional appeals. Emotional appeals often make products or services more salient, through the use of powerful human emotions such as fear, excitement, or humour to increase the engagement of the target.
3. Using comparisons. This is a technique where the price or quality of a product of service is compared to other supposedly similar instances. An uncompetitive product or service can be made to look better than it should, especially if the comparisons selected appear worse choices, increasing the likelihood of the target making the desired decision.

Use of Cognitive Bias in exams.

Most students would have noticed that the examples and explanations used are “not very Economics-like”, basing off feedback from schools’ teachers on how essays should be written for “A” level Economics.

Ignoring the unfortunate fact that Behavioural Economics is in fact a very recognised and integral part of the broader Economics study, it would appear that SEAB tacitly agrees, given:

1. The choice in the word “awareness” as the exhortation to students; and
2. The reference to cognitive bias appearing in the “Additional Information” section rather than in the main section.

Perhaps we can interpret this to be SEAB’s nod towards the continually increasing interest in behavioural processes influencing choices and allocations in Economics, but yet recognising that a fuller discourse in the mechanism and nuances of cognitive bias might be excessive for the syllabus.

In practical terms therefore, cognitive bias is likely to be tested as a peripheral concept. Potential scenarios include:

1. Suggestions of how firms may further reduce the price elasticity to its goods’ demand by tapping on cognitive bias, as high-order discussion/evaluation points in essays; or
2. Appearances in case studies, with questions requiring the identification with short explanation, of the cognitive bias mentioned.

We can expect the syllabus to evolve further and it will be interesting from my perspective, as an Economics teacher, to observe whether such syllabus requirements may further expand down the road.