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Role of AI in Behavioural Economics
Role of AI in Behavioural Economics

December 13, 2023

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The neo-classical economists believe that people make ‘rational decisions’. According to them, consumer preferences are based on maximizing their utility, and businesses aim to maximize their profits and minimize costs. In reality, though, most of the decisions are influenced by our inherent biases and lack of information. Thus, not all decisions are taken "optimally." Behavioral economics studies how psychology influences economic decision-making to understand why humans act in a particular way and make irrational decisions. This branch of economics deviates from traditional theories, and with the integration of artificial intelligence, the process of understanding human behavior has been made easier and less sophisticated. Let’s see how.

The foundation of AI-driven behavioral economics rests on its capability to handle and scrutinize extensive volumes of data. AI algorithms have the capability to identify correlations which can be applied in understanding human choices. In todays’ world, a plethora of choices are available to consumers, referred to as "overchoice." Consider an online shopping scenario. AI algorithms consistently monitor the users’ online behavior—searches, saved products, and history—and then use this data to recommend to these consumers the most relevant product of their choice. This saves time and increases sales, making e-shopping an overall nice experience. A study by McKinsey says companies that offer personalized experiences are estimated to earn 40% more revenue than their counterparts.

Similarly, AI algorithms make content recommendations on Netflix, Disney Hotstar, Amazon Prime, etc. as per the user’s preferred genre. Apparently, such recommendations have played a significant role in promoting the ‘binge-watching behavior’ among people.

Advanced AI algorithms can study facial expressions and subtle distinctions in voices to understand the emotional state of a person. Businesses can use this valuable data as it provides information about how consumers think of their products or services and modify their products or marketing strategies accordingly. Therefore, emotional AI can help predict consumers’ moods and convince them to make purchases.

Brain-Machine Interface, or smart brain, is a computer-based system that connects signals from the brain to an external device to monitor the brain's activities. BMI can be deployed in e-commerce and consumer applications. For instance, how attractive a particular advertisement is, how consumers perceive a given brand, what emotions come out when they see different varieties of ice cream, etc. All these can be answered with the data provided by this device, and firms can accordingly strategize.

Smartphone apps can induce positive behavior among people using AI. Getting a medical history and accordingly preparing a diet plan, providing personalized behavioral feedback like money saved by not smoking, etc. thus “nudging” individuals towards making healthier choices.

However, despite the enormous benefits that AI offers, there are certain limitations to its use. It can manipulate human choices. For instance, there was the ‘2018 Facebook scandal, in which politicians in the U.S. manipulated citizens’ votes in their favor. It breaches the privacy of individuals and exposes them to vulnerabilities.

While there is no denying that AI has excelled in numerous tasks, the central role of humans in decision-making will always remain undeniable.Role of AI in Behavioral Economics


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