4.1.2 Individual economic decision making

Question 1

What is rational economic decision making?

Answer 1

It is when economic agents must act rationally and make decisions soley based on trying to gain maximum utility possible and nothing else can ifluence their decision.

(They always try to maximise their own economic self-interest, asses the economic costs and benefits to themselves of making alternative choices)

Question 2

How do consumers act rationally?

Answer 2

A rational consumer will choose to consume a good at the point where marginal utility= price.

Question 3

Give an example of a rational consumer?

Answer 3

If the utility a person gains from eating a choclate biscuit is worth 10p than the rational consumer would pay 10p

If the utility gained from consuming a 2nd cookie is worth 8p than consumers will only pay 8p

Question 4

What is the law of diminishing marginal utility

Answer 4

As we consume more of an item the amount of satisfaction produced by each additional unit of that good declines

Question 5

Give an example of the law of diminishing marginal utilty?

Answer 5

If the marginal utility decreases with each extra good consumed then the price a consumer is willing to pay for each extra good will decrease.

Question 6

What does the law of diminishing marginal utility explain?

Answer 6

Why the demand curve is downward sloping.

Question 7

What is the utility theory?

Answer 7

When making economic decisions , consumers aim to maximise their utility and firms aim to maximise profits.

A consumers utility is the total satisfaction recieved from conuming a good or service.

Marginal utility is the extra satisfaction derived from consuming one extra unit of the good.

Question 8

What is utility maximisation?

Answer 8

Maximisation for consumers is when consumers aim to generate the greatest utility possible from an economic decision. Firms aim to generate the highest profit possible.

It’s assumed that economic agents only act in their own interest.

Question 9

What do economic agents respond to ?

Answer 9

Incentives- which can allocate scarce resources to provide thhe highest utility to each agent.

Question 10

What is an incentive for taking risks for an entrepreneur in a fim?

Answer 10

Profit.

Question 11

Give an example of a poitive incentive which will make consumers better off?

Answer 11

Rewards

Question 12

Give an example of a negative incentive which will make consumers worse off?

Answer 12

Penallties

Question 13

What happens when incentives are not given properly?

Answer 13

Resources will be misallocated

Question 14

Define what a margin is?

Answer 14

The margin is the change in variable casued by an increase of one unit of another variable

Question 15

Why is thinking at the margin important?

Answer 15

It allows consunmers to keep thinking ahead and prevets consumers thinking about things they have already done and allows them to consider how to maximise their total utility.

Question 16

What can margins help with?

Answer 16

It helps imprive productivity when making choices. Since, the most importat task which maximises the utility the most are the ones which are prioritised.

Question 17

Define Symmetric information?

Answer 17

It means that consumers and producers have perfect market information to make their decision

Question 18

What does symmetric information lead to?

Answer 18

Efficent allocation of resources

Question 19

Define imperfect information?

Answer 19

This is where information is missin so an informed decision cannot be ade

Question 20

What does imperfect information lead to ?

Answer 20

Misallocation of resources - as consumers may not pay the right amount and firms may produce the incorrect amount

Question 21

Define asymetric information

Answer 21

situation where one party in a transaction has more information than the other party

This is when there is unequal knowledge between consumers and producers.

Question 22

What does asymetric information lead to?

Answer 22

Market failure

Question 23

How does asymetric information lead to maret failure?

Answer 23

For example, a car dealer might know about a fault with the car that the consumer is unaware of. This could lead to a misallocation of resources. Consumers can also know more information than the producer, such as when purchasing insurance policies.

Question 24

What is asymetric information linked to?

Answer 24

The principle-agent problem.

Question 25

Define the principle -agent problem

Answer 25

When the agent makes decisions for the principal but the agent is inclined to act in their own intersts, rather than those of the principal.

Question 26

How can information be more widely available?

Answer 26

Through advertising or government intervention.

Question 27

How does imperfect information lead to market failure?

Answer 27

It makes it difficult for the economic agents to make rational choices and can eventually result in market failure. The buyers or sellers do not have the correct information then they may buy or sell a product at a higher or lower price than what would be reflective of its true benefit ot cost.

Question 28

What are the key assumptions used in traditional economic theory?

Answer 28

• Economic agents are utility maximisers
  -Economic agents are rational

Question 29

why do behavioural economists question the assumption of traditional economic theory ?

Answer 29

Behavioural economists challenge these assumptions because they are not seen as realistic. They look at the impact of social,psychological and emotional factors on decision making to try to make more realistic predictions about the decisions individuals make.

Question 30

What do behaviour economists do?

Answer 30

Behavioural economists incorporate ideas from psychology and other disciplines to enhance their understanding of economic decision making

Question 31

What viewpoint do behavioural economists ignore?

Answer 31

They reject the view that economic agents are fully ‘rational’ decision makers abd highight the importance of psychological biases,social and emotional factors.

Question 32

Define bounded rationality?

Answer 32

The ability of an individual to make rational decisions is servely restricted.

Question 33

Name three causes of bounded rationality?

Answer 33

• The human mind has limited ability to process and evaluate information.
• the information available is incomplete and unreliable
• the time available in which to make decisions is limited

Question 34

What do bounded rationaliy mean for people?

Answer 34

Behavioural economists argue that bounded rationality means people tend to satisfice rather than spend ages trying to make a rational decision which maximises utility.

Question 35

What is the term for a rational individual?

Answer 35

Homo economicus

Question 36

What does bounded rationality often lead to?

Answer 36

It leads to economic agents using heuristics (rule of thumb) to help them make decisions. This is because attempting to calculate and evaluate all possible outcomes takes too much effort and is complicated.

Question 37

Why are heuristics (rules of thumb) not always good idea?

Answer 37

When people adopt these rules of thumb they frequently lead to systematic and often predictable biases

Question 38

Define bounded self-control?

Answer 38

Assumes that conumers are able to exercise self-control.
Behavioural economists argue that individuals have limits on their self control and will only act to maximise their utility.

Where individuals lack the cognitive strength or will power to make rational decisions

Question 39

Give an example of bounded self control?

Answer 39

A consumer may have limited ability to stop smoking even though the act of smoking doesn’t maximise utility

Question 40

What do behavioural economists believe about self-control?

Answer 40

That when individuals recognise they have bounded self control can lead to the development of approaches that help improve social welfare.

Question 41

What causes biases in decision making?

Answer 41

Results from people adopting mental shortcuts, rule of thumb, which allows them to solve problems quickly.

Question 42

Give some examples of biases in decision making?

Answer 42

• The rule of thumb
• Anchoring
  -Availability bias
• Social norms

Question 43

What is the rules of thumb?

Answer 43

Simple,useful tools that help an individual make a decision (eg Choosing the middle priced option when faced with a range of different prices for similar products.

Question 44

What is anchoring?

Answer 44

It means placing too much emphasis on one piece of information.
eg ‘The first price quoted for a job cn influence an individuals view of what’s a fair price’

Question 45

What’s availability bias?

Answer 45

This is where the judgements are made about the probbability of events occurring based on how easy it is to remember such events occuring.

eg following a drought people will overestimate the probbability of a drought occuring the net year and make decisions based off this assumption.

Question 46

What is a social norm?

Answer 46

An individual’s behaviour can be influenced by the behaviour of their social group.

For example, an individual may stop buying ciggaretes if none of their friends smoke

Question 47

What is Altruism?

Answer 47

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

Question 48

what game can describe altruism?

Answer 48

The Ultimatum Game is used to describe altruism. 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.

Question 49

What is the percepetion of faireness?

Answer 49

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

Question 50

what are some of the reassons why an individuals economic decision may be biased?

Answer 50

Psychologists and behavioural economists have identified a large number of cognitive biases that can affect people’s behaviour.

Question 51

What are some examples of cognitive biases that can affect people’s behaviour?

Answer 51

• Confirmation bias = This happens when you look for information that supports your existing belief and reject data that goes against beliefs. This can lead you to make biased decisions
• Anchoring = The bias is the tendencay to jump to conclusions and base final judgement on information gained early on in the decision making process

Question 52

Why cant the governments social and economic policies using traditional economic theories not work in the real the world?

Answer 52

They are based on unrealistic asasumptions and they may not be useful.

Question 53

What might the government use instead of traditional economic theory?

Answer 53

Behavioural economis to help create policies .

Question 54

What is an observation provided by behavioural economicsts that bcan be used by governments (and producers) to influence the decisions of individuals or firms?

Answer 54

Choice architecture.

Question 55

Define choice architecture?

Answer 55

Where an individuals choice is influenced by adapting the way the choice is presented

Question 56

How can choice architecture be presented?

Answer 56

• Default option
• Framing
  -Nudges
  -Restricted choice

Question 57

What is default options?

Answer 57

People are more likely to choode the default option so this can be used to encourage individuals to act a certain way ,

Question 58

Define framing?

Answer 58

The context in which information is presented can influence a decision

Question 59

What is a nudge?

Answer 59

This where some alternatives are made easier to choose than others without removing the freedom of choice

Question 60

What is a retricted choice?

Answer 60

This occurs when peoples choices are restricted.

Question 61

What are mandated choices?

Answer 61

This is where people have to make a decision