1.2 How markets work

Question 1

rational choice theory

Answer 1

a framework for understanding and formally modelling social and economic behaviour based on the assumption that economic agents act rationally

Question 2

rational

Answer 2

in accordance with reason/logic

Question 3

net benefit

Answer 3

the sum of all the benefits of an outcome minus all the costs. each economic agent maximises a different net benefit.
consumers maximise benefit
workers maximise welfare at work
firm maximise profit (= revenue-costs)
governments maximise welfare of their citizens

Question 4

rational consumers

Answer 4

try to maximise their utility ( constrained by income). behaviour is rational if it is goal oriented, reflective and consistent ( across time and different choice situations)

Question 5

Homo economicus

Answer 5

a hypothetical model of humans who are infinitely rational and immensly intelligent, an emotionless being who can do cost analysis instantly, and is never ever wrong.

Question 6

utility

Answer 6

the satisfaction derived from the use of a good or service

Question 7

unit of utility

Answer 7

the util- an ‘ordinal’ measure used to rank the net benefits of different outcomes

Question 8

total utility

Answer 8

the total satisfaction an economic agent gains from all the units of a good consumed within a given time period

Question 9

marginal utility

Answer 9

the additional satisfaction gained from consuming one extra unit within a given time period

Question 10

diminishing marginal utility

Answer 10

as more units are consumed, additional units add less to satisfaction than previous units.

Question 11

when does max TU occur?

Answer 11

where MU=0, any more consumption and TU will start to fall

Question 12

relationship between MU and TU

Answer 12

MU gives the rate of change of TU. MU is the differential of TU
equation: MU= dTU/dQ

Question 13

behavioural economics

Answer 13

economic theory that tries to augment/replace traditional ideas of economic rationality from rational choice theory (homo economicus) with decision making models borrowed from psychology. it attempts to explain why people apparently make rational decisions

Question 14

homo sapiens

Answer 14

most of us are not infinitely rational but face ‘bounded rationality’ with people adopting simple,intuitive rules of thumb ‘ (heuristics) instead of calculating optimal solutions for every decision they make. we are open to influences outside of those covered in standard utility theory

Question 15

Failures of RCT

Answer 15

computational weaknesses
habitual behaviour
social/external influences

Question 16

computational weaknesses

Answer 16

problems recognising and defining the true net benefit of a choice

Question 17

Habitual behaviour

Answer 17

choices are made automatically based on routine rather than consideration of net benefts

Question 18

social/ external influences

Answer 18

factors that influence a decision outside the power of an economic agent