1.2 Individual economic decision making Flashcards
Rational behaviour
acting in pursuit of self-interest, which for a consumer means attempting to maximise the welfare, satisfaction, or utility gained from the goods consumed
What does traditional economic theory state?
consumers engage in rational behaviour
Demand
the quantity of a good that consumers are willing and able to buy at given prices in a given period of time
Utility
the satisfaction or economic welfare an individual gains from consuming a good
What are the units of utility?
Utils
Marginal utility
the extra satisfaction gained from consuming one extra unit of a good within a given time period
Point of satiation
when marginal utility equals zero
Principle of satiation
the effect whereby the more of a good one possesses the less one is willing to give up to get more of it
The law of diminishing marginal utility
for a single consumer the marginal utility derived from a good diminishes for each additional unit consumed
Why does the marginal utility curve slope downwards?
The law of diminishing marginal utility
Describe the relationship between the marginal and total utility curves
- the TU curve rises as long as the MU curve is positive
- the TU curve is highest when MU passes through the quantity axis
Behavioural economics
a method of economic analysis that applied psychological insights into human behaviour to explain how individuals make choices and decisions
Bounded rationality
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
Bounded self-control
limited self-control in which individuals lack the self-control to act in what they see as their self-interest
Imperfect information
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
Information gap
the difference between the perceived and true cost, benefit, or price
Asymmetric information
when one party to a market transaction possesses less information relevant to the exchange than the other
Rule-of-thumb
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
Demerit good
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
Merit good
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
Adverse selection
the tendency of those who are at greatest risk to take out insurance
Loss aversion
people’s tendency to prefer avoiding losses to acquiring equivalent gains
Framing
how something is presented influences the choices people make
Sunk costs
costs that have already been incurred and cannot be recovered
Cognitive bias
a systematic error in thinking that affects the decisions and judgements that people make
Availability bias
occurs when individuals make judgements about the likelihood of future events according to how easy it is to recall examples of similar events
Confirmation bias
the tendency for humans to only remember information that supports their own views
Representativeness bias
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
Altruism
concern for the welfare of others
Fairness
the quality of being impartial, just, or free of favouritism
Inequity aversion
the preference for fairness and resistance to incidental inequalities
Equality
everyone is treated exactly the same. A completely equal distribution of income means that everybody has the same income.
Equity
means that everyone is treated fairly
How does altruism challenge traditional economic theory?
- 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
Anchoring
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
Status quo bias
people generally prefer that things remain the same, or change as little as possible
Herd behaviour
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
Choice architecture
a framework setting out different ways in which choices can be presented to consumers, and the impacts of that presentation on consumer decision making
Shove
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
Nudge
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
Sensory cues
evocative smells and sights
Salience enhancements
making a choice relatively noticable
Convenience enhancements
making it easier to make certain choices
Default choice
an option that is selected automatically unless an alternative is specified
Mandated choice
people are required by law to make a decision
Restricted choice
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
