1.2.1 and 1.2.10 - rational decision making and consumer behaviour Flashcards
What is rationality?
The rational individual compares the costs and benefits of various options and selects the one which maximises personal net benefit or utility.
What is homo economicus?
Economists assume economic agents are rational and display the following traits:
1. maximising - they spend limited income in order to derive maximum utility
2. logical and consistent - if a consumer prefers coffee to tea, they can’t prefer tea to coffee
3. selfish - focus on personal benefit
4. insatiable - always preferring more to less
5. responsive to incentives - buying more when price falls
What is the price mechanism?
The rationing, signalling and incentive functions of the price mechanism allocate scarce resources to maximise social benefit. This is allocative efficiency.
What are the distortions that prevent the invisible hand guiding the market to allocative efficiency?
Information failures and asymmetric information.
What are information failures?
Consumers cannot maximise utility without complete information
What is asymmetric information?
When one party to an exchange has more information than the other. This leads to suboptimal behaviour and disrupts the price signal.
What is behavioural economics?
This adopts a psychological approach to explain why economic agents often behave irrationally. Rejects the assumption of homo economicus.
What is bounded rationality?
The ability of economic agents to make rational decisions is severely limited due to consumer weakness at computation: failures to evaluate and process info, imperfect info and limited time. This leads to satisficing or sub-optimal behaviour.
What is anchoring?
The tendency to place too much weight on one piece of information, usually the first received.
What is availability bias?
Judgements are made based on the probability of an event derived from personal experience rather than factual occurrence.
What are social norms?
Unwritten rules that influence individual behaviours
What is loss aversion?
Individuals value what they have rather than expected gains.
What is altruism?
Human behaviour motivated by kindness instead of self-interest
