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 benefit gained from consuming one extra unit of a good

Question 8

When is utility maximised (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

As quantity consumed increases, the marginal utility derived from each extra unit decreases

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 decisions-satisficing

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 overvalue 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

Adverse selection is a market phenomenon that occurs when the parties in a transaction have asymmetric information, meaning that one party has more or better information than the other party. This can lead to an imbalance in the transaction, as the party with the advantage can use their superior information to make decisions that are not in the best interest of the other party.

E.g the tendency of those who are of greatest risk to take out insurance

Or Akerlof’s Used Car Market

Or Labour Market (Asymmetric info in Employment)

Question 23

Loss aversion

Answer 23

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

Question 24

Framing bias

Answer 24

how something is presented influences the choices people make

Question 25

Sunk costs

Answer 25

Non-recoverable costs of leaving a market

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** ## Footnote Status quo bias and default bias are related concepts in behavioral economics and psychology, but they are not exactly the same. Here’s how they differ and overlap: Status Quo Bias Definition: The tendency to prefer the current state of affairs (the status quo) over change, even when change may be beneficial. Scope: Broad—applies to any situation where sticking with the existing option feels safer or easier. Example: Keeping the same insurance plan year after year instead of switching to a better one. Default Bias Definition: The tendency to favor the option that is presented as the default (pre-selected) choice, often due to inertia or perceived endorsement. Scope: Narrower—specifically tied to how choices are framed (default vs. non-default options). Example: Opting into a retirement savings plan because enrollment is automatic (vs. opting out). Key Differences Mechanism: Status quo bias is about resisting change in general. Default bias is about passively accepting a pre-set option. Context: Status quo bias can exist even without an explicit default (e.g., sticking with old habits). Default bias requires a default option to be presented (e.g., organ donation opt-in vs. opt-out systems). Overlap: Defaults often leverage status quo bias—people stick with them because they represent the "current" choice. But not all status quo bias involves defaults (e.g., preferring familiar brands isn’t about a default option). Practical Implications Defaults are a tool to exploit status quo bias (e.g., making healthier food the default in cafeterias). Status quo bias explains why defaults are so powerful—people dislike deviating from the current state. In short: Default bias is a specific form of status quo bias that arises when a default option is provided. All default biases involve status quo bias, but not all status quo biases involve defaults.

Question 38

Herd behaviour (Herding)

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 forbids a number of options or changes 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 ## Footnote The term "evocative" refers to something that brings strong emotions, memories, or mental images to mind. It is often used to describe words, art, music, or experiences that powerfully stir feelings or associations. Key Aspects of "Evocative" Emotional Resonance – Evokes deep feelings (e.g., nostalgia, joy, sadness). Example: "The song was so evocative, it reminded me of my childhood." Vivid Imagery – Creates a strong mental picture. Example: "Her writing is evocative, painting scenes so real I could almost see them." Suggestive Power – Implies more than it states, leaving an impression. Example: "The film’s ending was evocative, leaving the audience in thoughtful silence."

Question 43

Salience enhancements

Answer 43

**Salience enhancement is the deliberate design of choices or information to highlight specific attributes (e.g., price, quality, or risks) to steer decisions. It exploits the salience bias—the tendency to prioritize vivid or easily noticeable information over less prominent details** ## Footnote AQA Specification Relevance Under 4.1.2.3 (Aspects of Behavioral Economic Theory), AQA emphasizes biases like salience in consumer behavior. For example: Retail: Highlighting discounts (e.g., "50% OFF" in bold) makes price reductions more salient, increasing purchase likelihood 4. Policy: Governments may enhance the salience of health warnings (e.g., graphic images on cigarette packs) to deter smoking 7. Mechanisms of Salience Enhancement Visual Contrast: Using colors, fonts, or placement to make key information stand out (e.g., "limited stock" banners) 4. Framing: Presenting information in a way that emphasizes gains/losses (e.g., "Save £100" vs. "Lose £100 if you don’t act") 7. Contextual Timing: Aligning messages with moments of heightened attention (e.g., showing fridge ads when consumers search for refrigerators) 4.

Question 44

Convenience enhancements

Answer 44

**Convenience enhancements are modifications to the decision-making environment that simplify processes, save time, or minimise cognitive effort**, encouraging a desired behavior. ## Footnote Examples of Convenience Enhancements One-Click Purchasing (e.g., Amazon) Reduces steps to checkout, increasing impulse buys. Automatic Subscription Renewals Eliminates the need for manual renewal, exploiting inertia. Pre-filled Forms (e.g., tax or job applications) Lowers the effort required to complete tasks. Streamlined User Interfaces (e.g., mobile banking apps) Makes transactions easier, promoting usage. Healthy Food Placement (e.g., salads at eye level in cafeterias) Reduces the "effort" of choosing healthier options. How It Differs from Salience Enhancement Salience Enhancement = Makes information more noticeable (e.g., bold discounts). Convenience Enhancement = Makes actions easier to perform (e.g., auto-renewals). Both are tools of nudge theory, but they target different behavioral biases: Salience → Attention bias. Convenience → Inertia/effort aversion.

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 ## Footnote Mandated choice is a behavioral economics policy tool where individuals must actively make a decision—there is no default option or option to delay. It forces people to explicitly choose, increasing engagement and reducing inertia. Key Features (AQA Focus): Eliminates Defaults: Unlike automatic enrollment (e.g., opt-out pensions), mandated choice requires a deliberate selection. Aims to Overcome Inertia: By compelling action, it counters procrastination or passive acceptance of defaults. Used in Public Policy: Common in organ donation systems, pension schemes, or ethical consumer choices (e.g., "Do you want to donate to charity? Yes/No"). Examples (AQA Exam Context): Organ Donation: Some countries require drivers to check "Yes/No" on donor status when applying for a license. Pension Plans: Employers may force employees to actively select contribution rates rather than auto-enrolling them. Ethical Opt-Ins: Supermarkets asking customers to choose "paper or plastic" bags at checkout (banning neutral non-choice). Comparison with Other Nudges (AQA Evaluation): Policy Tool How It Works Advantage Disadvantage Mandated Choice Forces active decision (no default) Encourages engagement; respects autonomy May overwhelm or annoy ("choice fatigue") Default Bias Opt-out systems (e.g., pensions) High uptake due to inertia Seen as manipulative; less conscious choice Salience Enhancement Highlights key info (e.g., bold prices) Guides attention transparently May distract from other important factors AQA Exam-Style Question: "Evaluate the effectiveness of mandated choice compared to default policies in increasing organ donor registrations." Possible Points: ✅ Strengths: More ethical (avoids "nanny state" criticism by requiring consent). Creates conscious commitment (e.g., donors may feel more ownership). ❌ Weaknesses: Lower participation rates than opt-out systems (default bias exploits inertia). Risk of decision paralysis (some may refuse to choose).

Question 47

Restricted choice

Answer 47

**Restricted choice refers to a policy or strategy that limits the number or type of options available to individuals in order to simplify decision-making, reduce cognitive overload, and steer behavior toward desired outcomes.** -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 ## Footnote Key Features (AQA Focus) Reduces Complexity: By narrowing options, it prevents "choice overload" (where too many options lead to indecision or dissatisfaction). Guides Behavior: Strategically curated choices can promote healthier, more ethical, or economically beneficial outcomes. Not a Ban: Unlike mandates, restricted choice still allows some autonomy—just within a controlled framework. Examples in Economics & Business (AQA Context) Pension Plans: Employers may offer a limited selection of investment funds (e.g., 3 risk-tiered options) to prevent confusion. Healthy Eating Initiatives: Schools/cafeterias restrict junk food options while keeping healthier meals available. Environmental Policies: Governments may limit plastic bag options (e.g., only thick reusable bags for sale) to reduce waste. Retail Strategies: Subscription services (e.g., Netflix) offer limited pricing tiers to streamline decisions. Comparison with Other Nudge Tools Policy/Nudge How It Works Pros Cons Restricted Choice Limits options to simplify choices Reduces decision fatigue; improves outcomes May feel paternalistic; less consumer sovereignty Mandated Choice Forces active yes/no decision Encourages engagement May annoy users; lower compliance if forced Default Bias Sets pre-selected opt-out option High uptake due to inertia Ethical concerns (exploits passivity) AQA Exam Application Potential Question: "Discuss how restricted choice could be used to encourage healthier eating habits among students." Sample Points: ✅ Effectiveness: Cafeterias offering only fruit (no candy) as snacks nudges students toward better choices without banning alternatives elsewhere. Simplified menus reduce "overchoice," making decisions quicker and more satisfying (supported by Iyengar & Lepper’s jam study). ❌ Limitations: Perceived as overly controlling (critics argue it reduces personal responsibility). May backfire if students seek unrestricted options outside school (e.g., fast food). Synoptic Link: Connects to government intervention (4.2.5) and market failure (e.g., information gaps/health externalities). Evaluation for High Marks To critique restricted choice, consider: Ethics: Does it balance paternalism with freedom? Effectiveness: Does it actually change long-term behavior, or just compliance in the short term? Alternatives: Could salience enhancement (e.g., labeling) or price incentives (e.g., sugar taxes) work better?