1.2.1 Behavioural economics and rational decision making Flashcards
What does traditional economic theory assume about economic agents?
Economic agents want to maximise their utility
What does rational decision making mean?
Economic agents will make decisions based solely on trying to gain the maximum utility possible and nothing else will influence either decision making.
What is marginal utility?
The benefit gained from consuming an additional unit of a good.
What is total utility?
The overall benefit gained from consuming a good.
What is diminishing marginal utility?
Where as consumption increases, the marginal utility derived from each additional unit consumed decreases. (Where a consumer is less satisfied with every additional unit of good they are consuming).
Example of diminishing marginal utility.
Example: All you can eat buffets – people want food less, the more they eat.
Another example of diminishing marginal utility:
- 1st bar of chocolate eaten = Brings the most utility
- 2nd bar of chocolate eaten = Brings high utility
- 3rd bar of chocolate eaten = Brings further utility, but less than the 1st and 2nd bar.
- 4th bar of chocolate eaten = Some utility, but not as much as the other bars.
The objective of consumers
Consumers are traditionally assumed to want to maximise their utility, whilst not spending more than their income.
Utility will involve different things for different people, but regardless of what they spend their money on, it is assumed they will act rationally.
Consumers can also act as workers. Workers are assumed to want to maximise their income, while having as much free time as they need or want.
The objective of producers
The main objective of a firm is to maximise profits.
Firms may also want to maximise other things such as total sales or the firm’s market share.
- A large market share could lead to some monopoly power – this would mean the firm could charge higher prices due to a lack of competition.
Some firms may also have ethical objectives. For example, a firm may decide to buy all its raw materials from nearby suppliers in order to support the local economy, even if cheaper alternatives are available elsewhere.
A firm’s profit is their total revenue minus total costs.
The objective of governments
Governments try to balance the resources of a country with the needs and wants of the population – to maximise the “public interest”.
This is likely to include:
- Economic growth
- Full employment
- Equilibrium in the balance of payments
- Low inflation
In practice, these are competing objectives – policies that help achieve one objective may make it more difficult to achieve another (e.g. increased government spending may help to create jobs, but could lead to higher inflation).
Asymmetric information
When one party has more information than the other in a transaction. E.g. Sellers often have more information than buyers as the seller will know how much a product actually costs to make and what its true value is.
Why might consumers not act rationally?
- Limited time
- Imperfect information
- Habits
What are the ways individuals are influenced by bias?
- Rules of thumb
- Anchoring
- Availability bias
- Social norms
- Habitual behaviour
