2.3 Aspects Of Behavioural Economic Theory

Question 1

Individuals are…

Answer 1

-rational decision makers who try to maximise their utility.

Question 2

Who recognised the limitations of the decision making model?

Answer 2

-Herbert Simon

-So he devised the bounded rationality model, also known as the administrative man theory.

Question 3

What are the assumptions of the bounded rationality model?

Answer 3

o The first alternative that is satisfactory is selected

o The decision maker recognises that they perceive the world as simple

o The decision maker recognises the need to be comfortable making decisions without considering every alternative

o Decisions could be made by heuristics.

Question 4

What does bounded self-control assume?

Answer 4

-assumes consumers are unable to exercise self-control.

Question 5

When are consumers unable to exercise self-control?

Answer 5

-However, consumers are unable to exercise self-control with some decisions.

-The law of diminishing marginal utility suggests that every extra unit consumed provides
a smaller benefit to the consumer.

Question 6

Give another example of when consumers are unable to exercise their self-control

Answer 6

• Another example could use the short term and long term view.
• Consumers know that it will benefit them in the long run if they save for their pension, but this will limit their spending in the short run.
• Spending less in the short run instils fear in the consumer, even if they are aware that unless they save, they will not be able to consume as much in the long run.
• With the long run view, consumers feel as though they ‘could always start saving tomorrow’.
• It is this procrastination which leads to consumers making irrational decisions by not having self-control.

Question 7

Consumers are not always rational

Answer 7

• Consumers do not always act rationally.
• Acting rationally means making a decision that results in the most optimal level of utility or benefit for the consumer.

Question 8

Biases in decision making: What are rules of thumb?

Answer 8

• a practical principle or guideline that can be used as a rough basis for making decisions or solving problems.
• Often based on experience or observations, and they can be useful in situations where exact calculations are not necessary or possible.

Question 9

Biases in decision making:
What are social norms?

Answer 9

• The behaviour of other people affects how the consumer acts.
• Other people’s behaviour creates a bias within the consumer.
• This social pressure encourages consumers to do things they would not otherwise do, or that they know
  could be harmful.
• Consumers become unwilling to change, even if it is of benefit to
  them, if it goes against the norms of their society.

Question 10

Biases in decision making:
What is anchoring?

Answer 10

• type of bias created by the human tendency to rely on the first piece of information they are given.
• This first piece of information causes consumers to be biased towards it when subsequent information is given.
• For example, if a car’s original price is high, but it is on sale for a lower price,
  consumers will be inclined to think this is reasonable, even if the lower price is more than the car’s value.

Question 11

Biases in decision making:
What is availability?

Answer 11

• a form of bias towards events that were recent, personal or memorable.
• This is because they are overestimated and cause emotional responses.
• This then influences how the consumer behaves and this type of bias is spread across populations by reporting them in the news and
  media.
• For example, consumers are likely to think plane accidents are much more likely to occur, if they have been involved in one or know someone else who has. Even though they are very rare, they overestimate the probability.

Question 12

What is Altruism?

Answer 12

• the act of being selfless and considerate towards other people.

Question 13

What concept is used to describe Altruism?

Answer 13

• The Ultimatum Game

Question 14

What is the ultimatum game?

Answer 14

• There are two players: a proposer
  and a responder.
• The proposer has to offer the responder a portion of the sum of
  money they are given.
• The proposer can choose how much to offer.
• The responder can either accept or decline the offer.
• If the responder accepts the offer, the sum of money is divided.
• If the responder declines the offer, both players receive nothing.
• Proposers do not just offer the minimum amount. Usually, it is in the range of 40%-50% of the total.
• Responders usually accept offers above 25%.

Question 15

What is the importance of Altruism?

Answer 15

• This highlights the perception of fairness.
• Proposers and responders do not aim to get as much money as possible, but they aim to distribute the money according to what is considered fair.
• Responders choose to accept nothing rather than be treated unfairly (with offers below 25%).
• This essentially ‘punishes’ the proposer for treated them unfairly by
  offering a small amount.
• Proposers might try and be fair, but they also try to offer an amount which will be accepted by the responder.