(2) Individual Economic Decision Making

Question 1

Utility theory:

What is utility a measure of ?

Answer 1

• utility is a measure of satisfaction from consuming a good or service

Question 2

Utility theory:

What is utility in economics?

Answer 2

• Is the satisfaction one receives from consuming a of good or service

Question 3

Utility theory:

Why is the utility theory helpful for economists

Answer 3

• It is helpful as it is used as a theoretical construct to help economists understand and model human behaviour - (even if it’s not directly measurable in an objective sense)

Question 4

Utility theory:

Why is this concept used with individuals

Answer 4

• It is used to understand the subjective preferences of individuals, when it comes to them making decision on how to allocate their limited budget

Question 5

Utility theory:

What is marginal utility ?

Answer 5

• Marginal utility is the additional satisfaction or utility gained from consuming one more unit of a good or service

Question 6

Utility theory:

The law of diminishing marginal utility

Answer 6

• States that as a person consumes more units of a particular good or service (while keeping the consumption of other products constant), the additional satisfaction or marginal utility gained from each additional unit will decrease

Question 7

Utility theory:

Why are people more willing to buy more of a good when the price is lower

Answer 7

• Because a cut in price makes each additional unit more valuable in terms of the satisfaction it provides

Question 8

Utility theory:

What is disutility

Answer 8

• It is the opposite of utility and it refers to the negative feeling, discomfort associated with certain goods or services

Question 9

Utility theory:

What is an example of disutility

Answer 9

• Unpleasant work: jobs that are physically demanding
• travelling in crowded, uncomfortable public transport

Question 10

Utility theory:

When is total utility maximised

Answer 10

• When consuming an additional unit of the particular product no longer provides any extra satisfaction - marginal utility is zero.

Question 11

Utility theory:

What is the rational choice theory?

Answer 11

• Assumes that consumers always behave rationally in allocating their limited budget between different products to maximise total satisfaction from their purchases

Question 12

Utility theory:

difference with maximising utility with single products and multiple products

Answer 12

• With a single product, the total utility is maximised when marginal utility is zero
• With multiple products - the condition for maximising utility is that consumer equalises the marginal utility per pound spent

Question 13

Utility theory:

What is the condition for maximising total utility

Answer 13

MU of A / P of A = MU of B / P of B

Mu - marginal utility
P - price

Question 14

imperfect information:

What is information essential for

Answer 14

• It is essential for making sound economic decisions

Question 15

imperfect information:

what is impossible without information

Answer 15

• It is impossible to properly evaluate costs and benefits or make informed decisions

Question 16

imperfect information:

What could occur when there is imperfect information

Answer 16

• market failure

Question 17

imperfect information:

what is information Gaps

Answer 17

• information gaps is when people have uncertain or incomplete data and so could make potentially wrong choices in markets.

Question 18

imperfect information:

what are two examples of imperfect information

Answer 18

• uncertain quality of secondhand products
• builders

Question 19

imperfect information:

when does asymetric information occur

Answer 19

• asymetric informations occurs when sombody knows more than somebody else in the market

Question 20

imperfect information:

what is asymetric information

Answer 20

• is when one party in a transaction has more or less information than the other, giving the one with more information an advantage

Question 21

imperfect information:

what can asymetric information lead to

Answer 21

• leads to problems in decision making, since the party with less information may not have all information needed to make the best choice

Question 22

imperfect information:

give three examples of asymetric information

Answer 22

• doctors: have superior knowledge about drugs and treatments
• used car sellers: know more about the vehicle quality than the potential buyer
• landlords: know more about their properties than tenants

Question 23

imperfect information:

interventions to improve information

Answer 23

• health warnings
• nutritional labelling
• industry standards

Question 24

imperfect information:

what is the paradox choice

significance of information gaps

Answer 24

• choice overload can distort our decisions -> most people have bounded rationality

Question 25

imperfect information:

what can fake news and misleading advertising lead to

significance of information gaps

Answer 25

• leads to a loss of allocative efficency

Question 26

what can information failure affect

significance of information gaps

Answer 26

• it can affect equity - such as students from poorer backgrounds finding it hard to access the best universities

Question 27

imperfect information:

why is behavioural intrerventions useful

significance of information gaps

Answer 27

• it can impact and make a difference for the economy, however, “hard” nudges may be needed such as compulsory vaccinations.

Question 28

imperfect information:

what is the idea of bounded rationality

Answer 28

• humans have limited cognitive resources and are unable to make completely rational decisions

Question 29

imperfect information:

how are information gaps & bounded rationality related (who pioneered this)

Answer 29

• the existence of information gaps is directly related to the concept of bounded rationality, which was pioneered by nobel Laureate Herbet Simon

Question 30

imperfect information:

linking to bounded rationality - what must humans make decisions on

Answer 30

• they must make decisions based on the information they have available, and when there are information gaps, it can lead to sub-opytimal choices (in such cases, they rely on heuristics to simplify complex decision-making processes)

Question 31

imperfect information:

what does bounded rationality also take account off

Answer 31

• it takes account the cost of acquiring and processing information

Question 32

imperfect information:

what are heuristics

Answer 32

• they are mental shortcuts that we use to make decisions quickly and efficiently

Question 33

imperfect information:

what do Heuristics help us make

Answer 33

• they help us make decisions without having to consider all the information available.

Question 34

imperfect information:

what is anchoring heuristic

Answer 34

it is where we rely heavily on the first piece of information we recieve to decide

Question 35

imperfect information:

what are the four examples of heaurtics used in decision-making

Answer 35

• price-Quality heauristic
• familiarity heuristic
• brand loyalty heauristic
• availability heauristic

Question 36

imperfect information:

example of heuristic - price-quality Heauristic

Answer 36

• many consumers assume that higher-priced products are of better quality. They may choose a more expensicve brand believing it will offer superior performance or durability.

Question 37

imperfect information:

example of heuristic - familiarity heuristic

Answer 37

• consumers often choose brands or products they are familiar with because they feel a sense of trust

Question 37

imperfect information:

example of heuristic - brand loyalty heuristic

Answer 37

many consumers stick with the same brand for years if their preffered brand consistently delivers satisfaction and quality

Question 38

imperfect information:

example of heuristic - availabilty heuristic

Answer 38

• when consumers recall instances of a product or brand readily, they are more likely to choose it.