1.2 Individual economic decision making

Question 1

Rational behaviour

Answer 1

acting in pursuit of self-interest, which for a consumer means attempting to maximise the welfare, satisfaction, or utility gained from the goods consumed

Question 2

What does traditional economic theory state?

Answer 2

consumers engage in rational behaviour

Question 3

Economic good

Answer 3

something that is consumed to satisfy wants and provides utility

Question 4

Demand

Answer 4

the quantity of a good that consumers are willing and able to buy at given prices in a given period of time

Question 5

Utility

Answer 5

the satisfaction or economic welfare an individual gains from consuming a good

Question 6

What are the units of utility?

Answer 6

Utils

Question 7

Marginal utility

Answer 7

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

Question 8

Point of satiation

Answer 8

when marginal utility equals zero

Question 9

Principle of satiation

Answer 9

the effect whereby the more of a good one possesses the less one is willing to give up to get more of it

Question 10

The law of diminishing marginal utility

Answer 10

for a single consumer the marginal utility derived from a good diminishes for each additional unit consumed

Question 11

Why does the marginal utility curve slope downwards?

Answer 11

The law of diminishing marginal utility

Question 12

Describe the relationship between the marginal and total utility curves

Answer 12

• the TU curve rises as long as the MU curve is positive
• the TU curve is highest when MU passes through the quantity axis

Question 13

Behavioural economics

Answer 13

a method of economic analysis that applied psychological insights into human behaviour to explain how individuals make choices and decisions

Question 14

Bounded rationality

Answer 14

when making decisions, an individual’s rationality is limited by the information they have, the limitations of their minds, and the finite amount of time available in which to make decisions

Question 15

Bounded self-control

Answer 15

limited self-control in which individuals lack the self-control to act in what they see as their self-interest

Question 16

Imperfect information

Answer 16

where economic agents are not completely and immediately aware of costs, benefits, or prices that are relevant to their decisions, such as the external costs and benefits

Question 17

Information gap

Answer 17

the difference between the perceived and true cost, benefit, or price

Question 18

Asymmetric information

Answer 18

when one party to a market transaction possesses less information relevant to the exchange than the other

Question 19

Rule-of-thumb

Answer 19

a rough and practical method or procedure that can be easily applied when making decisions. Mental shortcuts for decision making to help people make quick and satisfactory decision

Question 20

Demerit good

Answer 20

a good, such as tobacco, for which the social costs of consumption exceed the private costs. Alternatively or additionally, an information gap exists so consumers over appreciate the benefits of consumption

Question 21

Merit good

Answer 21

a good, such as healthcare, for which the social benefits of consumption exceed the private benefits. Alternatively or additionally, an information gap exists so consumers underappreciate the benefit of consumption

Question 22

Adverse selection

Answer 22

the tendency of those who are at greatest risk to take out insurance

Question 23

Loss aversion

Answer 23

people’s tendency to prefer avoiding losses to acquiring equivalent gains

Question 24

Framing

Answer 24

how something is presented influences the choices people make

Question 25

Sunk costs

Answer 25

costs that have already been incurred and cannot be recovered

Question 26

Cognitive bias

Answer 26

a systematic error in thinking that affects the decisions and judgements that people make

Question 27

Availability bias

Answer 27

occurs when individuals make judgements about the likelihood of future events according to how easy it is to recall examples of similar events

Question 28

Confirmation bias

Answer 28

the tendency for humans to only remember information that supports their own views

Question 29

Representativeness bias

Answer 29

when people are assessing the similarity of objects they are likely to judge wrongly because the fact that something is more representative does not actually make it more likely

Question 30

Altruism

Answer 30

concern for the welfare of others

Question 31

Fairness

Answer 31

the quality of being impartial, just, or free of favouritism

Question 32

Inequity aversion

Answer 32

the preference for fairness and resistance to incidental inequalities

Question 33

Equality

Answer 33

everyone is treated exactly the same. A completely equal distribution of income means that everybody has the same income.

Question 34

Equity

Answer 34

means that everyone is treated fairly

Question 35

How does altruism challenge traditional economic theory?

Answer 35

• rational consumers would only consider personal utility maximisation when making consumption decisions
• altruists can often act in a way that has a great personal cost

Question 36

Anchoring

Answer 36

a cognitive bias describing the human tendency when making decisions to rely too heavily on the first piece of information offered (called the anchor). Individuals use an initial piece of information when making subsequent decisions

Question 37

Status quo bias

Answer 37

people generally prefer that things remain the same, or change as little as possible

Question 38

Herd behaviour

Answer 38

making decisions based on the behaviour of others, which can cause people to make decisions as a group that they wouldn’t make as individuals

Question 39

Choice architecture

Answer 39

a framework setting out different ways in which choices can be presented to consumers, and the impacts of that presentation on consumer decision making

Question 40

Shove

Answer 40

any method of altering people’s behaviour that either forbid a number of options or changing economic incentives. E.g. banning the use of recreational drugs, taxes, subsidies

Question 41

Nudge

Answer 41

any aspect of choice architecture that alters people’s behaviour in a predictable way without forbidding any options or significantly changing economic incentives. The intervention must be easy and cheap to avoid. E.g. putting fruit at eye level

Question 42

Sensory cues

Answer 42

evocative smells and sights

Question 43

Salience enhancements

Answer 43

making a choice relatively noticable

Question 44

Convenience enhancements

Answer 44

making it easier to make certain choices

Question 45

Default choice

Answer 45

an option that is selected automatically unless an alternative is specified

Question 46

Mandated choice

Answer 46

people are required by law to make a decision

Question 47

Restricted choice

Answer 47

offering people a limited number of options so that they are not overwhelmed by the complexity of the situation. If there are too many choices, people may make a poorly thought-out decision or not make any decision