2.3 Aspects Of Behavioural Economic Theory Flashcards
What is behavioural economics?
Method of economic analysis that applies psychological insights into human behaviour to explain how humans make choices and decisions
What is behavioural economics built on?
Insights of of psychologists seeking to understand human behaviour and decision making
When did the UK gov set up BIT and what does it do?
2010
Behavioural insights team based in the cabinet initially
What does the BIT’s website state?
“Seek to understand how individuals take decisions in practise and how they are likely to respond to options”
What did Dan Ariely state in his book Predicable irrational?
Traditional economics is about creating a theory and using it to explain actual behaviour
whereas behavioural economics is about observing actual behaviour and coming up with a theory
Why are traditional theories attacked by behavioural economics?
Because they simplify assumptions on which the theories are built and are therefore unrealistic
What assumption do behavioural economists query and why?
“Profit-maximising assumption”-entrepreneurs make business decisions solely on if it will make more profit
What did Milton Friedman state in ‘the methodology of positive economics’?
“Truly important and significant hypothesis will be found to have assumptions that are wildly inaccurate descriptive representations of reality”
(In general the more significant the theory the more unrealistic the assumptions)
What did Friedman reject?
Testing a theory solely based on assumptions
What was Friedman’s core argument?
A theory should be tested or rejected on on the basis of the validity and fruitfulness of its predictions
What do the traditional theories of a firm state?
-entrepreneurs are assumed to produce and sell up to the point at which
Marginal revenue=marginal cost
What does homo economicus mean?
portrayal of humans as agents who are consistently rational and narrowly self-interested, and who pursue their subjectively defined ends optimally
Home economicus translation
Economic man
What does behavioural economics think about homo economicus?
Seeks to move beyond it to a more realistic representation of how people choose to behave
What are the three ways behavioural economics attempts to move past homo economicus?
- -anomalies that defy rationality
- Research from the field of cognitive psychology
- Humans face substantial limitations of computation and reasoning
behavioural economics attempts to move past homo economicus:
Way 1
People can be altruistic and care for the well-being of others also humans can be impatient and lack self control
behavioural economics attempts to move past homo economicus?
Way 2
Humans often make decisions using simple rules of thumb (heuristics)-and suffer from forms of bias
-emotions are also heavily involved in decision making
behavioural economics attempts to move past homo economicus?
Way 3
Complex environments: when people are acting strategically their best actions is dependent on what others choose to or
-e,g a firm setting a price will first have to wait and see what it’s competitors are doing
In the world decisions are made in……
Bounded rationality
What is bounded rationality?
When making decisions, individuals’ rationality is limited to the information they have, the limitations of their mind and finite amount of time available to make decisions
What is bounded rationality closely linked with?
Bounded self control
What is bounded self-control?
Limited self-control in which individuals lack the self-control to act in what they see as their self-interest
What does traditional economics assume about self control?
Everyone has complete self control all the time
Give an example of how self control can be limited?
New Years resolutions
-daily jog everyday but a little bit of bad weather leads the resolution being broken
What did noble peace prize winner Kahbeman come up with?
Humans think in two different ways
1.”thinking fast”-instinctive little effort made in decisions
- “Thinking-slow”-reflective thinking, metal effort is needed to work through a problem before a decision can be made
What system falls under the “thinking fast”?
The automatic system
What system falls under reflective thinning?
Reflective systems
What is wrong with quick decisions?
They are heavily biased
What is cognitive bias?
A systematic error in thinking that affects decisions and judgments people make
Give a type or cognitive bias?
Confirmation bias which is the tendency to seek information that matches what one believes
What are rules of thumb used for?
To make sensible decisions based on limited information but the decisions are prone to cognitive bias
What are the two common rules of thumb?
-anchoring
-availability bias
What is availability bias and when does it occur?
When individuals place to much weight on the probability of an event happening because they recall vivid examples of similar events
Give an example of availability bias?
Buying a lottery ticket
Not a rational decision to buy one but people focus on the stories of the winners and decided to buy a ticket despite a small chance of winning
What is anchoring?
Congestive bias describing human tendency when making decisions to reply to heavily on the first piece of information offered
-this piece of information is used in the subsequent judgments
Give an example of anchoring?
Restaurant menus’
-choose cheapest item over expensive items even though prices might be still high
-often the middle option is selected, not to expensive and not to cheap
What are social norms?
Forms or patterns of behaviour considered acceptable by society or a group within society
Give an example of a negative social norm?
Young people having alcohol
What are nudges?
Factors which encourage people to act and think in a particular way
-nudges try and shift group and individual behaviour in ways to comply with desirable social norms
Give an example of positive social norms?
-no longer socially acceptable to smoke in society
What is altruism?
Concern for the welfare of others
What is fairness?
Quantity of being impartial (just or free from favouritism)
-treating people equally sharing with others and giving others respect and time and not taking advantage of them
What is the negatives with altruism?
We suffer the consequences financially, at a personal risk or loss of time
Dispute altruism not being common in traditional economic theory where was it present p?
Individuals receive satisfaction by giving to others and therefore it is still acting in the self interest
What is the first impulse of humans?
To co-operate rather than compete
Framing?
Bias on how information is presented to you
What is the loss of aversion?
Non gamblers out of fear of losing what they have
