1.2.1 - Rational Decision Making Flashcards
State the underlying assumptions of rational economic
decision making (in classical and neoclassical economics)
1) Economic agents are utility maximisers
2) economic agents are rational
therefore, spec says
o consumers aim to maximise utility
o firms aim to maximise profits
State the problem and solution in economic decision making?
Problem: assumptions must be made about the behaviour of economic agents to create economic models
Solution: make a deductive or inductive assumption
What is a deductive approach
Starting with evidence
- classical school of econ: adam smith
- neoclassical school of econ: alfred marshall
What is an inductive approach
Collecting evidence
- Keynesian: Joan Robinson
- Behavioral: Richard Thaler
Define utility
Satisfaction or benefit derived from consuming a good
How can a firm maximise their utility
Their utility = profit
By..
- making things consumer want and can afford
- producing efficiently as possible
What three conditions do economic agents need for rational decision making
- time
- information
- ability to process the information
What does bounded rationality mean
Economic agents cannot make rational decisions as the may not have the time, information or ability to process the information involved in making a decision
What prevents rational decision making
- habitual behaviour/consumer inertia
- people are influenced by the decisions of others
- consumer weakness at computation
What is behavioural economics
School of economics based on evidence and observations to develop assumption in economic decision making - inductive approach
State one assumption made in behavioural economics
individuals have bounded rationality; they wish to maximise utility but are unable to do so due to a lack of time, information and ability to process information so they make a satisfactory decision instead.
Why do behavioural economists argue that individuals have bounded self-control
A rational individual is assumed to have total self-control and will only act to maximise utility but really they have limited self control (e.g smokers won’t max utility but they can;t stop it)
