12.2 Behavioural Economics - Cognitive BIases Flashcards
Q1: What are cognitive biases as argued by behavioural economists?
A1: Behavioural economists argue that emotional, psychological, and social factors can influence decision-making, deviating from the traditional neoclassical view of rational, utility-maximizing decisions. These factors are known as cognitive biases, which can lead individuals to make decisions that may not align with perfect rationality.
Q2: What is anchoring bias and how does it affect consumer decisions?
A2: Anchoring bias occurs when a value is imprinted in the minds of consumers as a reference point to judge the value of a good or service. For example, when shops display the recommended retail price (RRP) alongside the discounted price, consumers may feel they are getting an excellent deal based on the comparison to the higher RRP. This bias can influence consumer perceptions of value and lead to decisions that may not necessarily reflect the true value of the product.
Q3: How do social norms impact consumer decision-making?
A3: Social norms influence consumer decisions based on societal etiquette and expectations of behavior. Consumers may make decisions based on how other people in society act. For instance, tipping in restaurants has become a social norm in many countries, even though the same practice may not extend to other contexts, such as visiting someone’s house for dinner. Social norms shape consumer behavior and can lead to decisions that align with societal expectations.
Q4: What is availability bias and how does it affect decision-making?
A4: Availability bias occurs when consumers make decisions based on the ease with which information is available to them. This bias can lead individuals to rely heavily on readily available examples or information that may not be representative of the overall evidence or statistical trends. For example, someone may ignore the abundance of evidence suggesting that smoking is harmful because they personally know someone who has smoked for years and appears healthy. Availability bias can lead to irrational decision-making based on anecdotal or easily accessible information.
Q5: How does framing influence consumer decisions?
A5: Framing refers to the way information is presented and how it can influence consumer decisions. For instance, the packaging of food products highlighting “low fat” or “low sugar” can influence consumers’ choices. Similarly, the way questions are framed in surveys or on ballots can impact individuals’ responses. Framing can shape perceptions and preferences, leading to different decision outcomes based on how information is presented.
Q5: What is loss aversion and the endowment effect?
A5: Loss aversion and the endowment effect refer to the tendency of individuals to make decisions that avoid losses rather than acquiring exactly the same gains. In other words, individuals weigh losses more heavily than equivalent gains. For example, consumers may prefer not to lose €10 rather than find €10. This bias can influence decision-making, such as when consumers choose what to do with their savings. Despite the potential for gains in lucrative investments with minimal chance of loss, individuals may opt for saving money in a bank account with low interest, where there is no chance of losing the money. The fear of potential loss outweighs the potential gains, leading to a different decision being made.
Q6: What is herding behavior, and why is it considered dangerous?
A6: Herding behavior refers to individuals following trends or “jumping on the bandwagon” when making decisions. For example, if many investors start buying a particular share, driving up its price, others may also decide to buy the same share, believing it to be the right decision because everyone else is doing it. The same can occur in the housing market, where individuals buy houses despite the market potentially heading for a downturn. Herding behavior is particularly dangerous in financial and housing markets as it can contribute to the formation of bubbles, where prices become excessively high relative to the true worth of goods or services. Eventually, these bubbles can burst, leading to a sector collapse, recession, lower incomes, and high unemployment in the economy. Herding behavior can amplify market volatility and contribute to market instability.
