4.2 Behavioural economics

Question 1

What is behavioural econoimcs

Answer 1

Focuses on finding examples where real-life economic agents do not act like homo economicus

Question 2

3 examples where humans don’t act like homo economicus and make perfect decisions

Answer 2

1) Bounded Rationality and self-control
2) Systematic biases
3) Altruism

Question 3

Define bounded rationality

Answer 3

Is the idea that when individuals make decisions, their rationality is limited by the information they have, the cognitive limitations of their minds, and the time available to make the decision, so they often accept near enough solutions

Question 4

What 3 things make up the bounded rationality theory

Answer 4

1) Computation
2) Imperfect Information
3) Time

Question 5

Define computation in bounded rationality theory

Answer 5

Humans cannot perform exact complex calculations

Question 6

Define Imperfect Information in bounded rationality theory

Answer 6

Humans don’t have access to all relevant information, most markets lack perfect information

Question 7

Define Time in the bounded rationality theory

Answer 7

Humans have to make decisions on the spot and cannot take time to consider the costs and benefits

Question 8

Who created the theory of bounded rationality

Answer 8

Herbert Simon, said that humans do try to make the best decision, but often accept near enough solutions

Question 9

What does bounded rationality mean split?

Answer 9

Rationality - Agents attempt to apply rationality and reason to decisions
Bounded - They often don’t achieve perfect rational decisions as their ability to do so has an upper bound.

Question 10

What is bounded self control

Answer 10

Homo economicus is always able to make himself take beneficial actions, To question the idea that individuals are able to exercise self-control when presented with certain choices.

Question 11

What is an example of bounded self control

Answer 11

Jenny going the gym

Question 12

What does the example of bounded self control show

Answer 12

Makes us question if it was irrational or lack of self control
Shows humans cannot always have the ability to make themselves do the best for themselves
self control has an upper bound

Question 13

Define cognitive Bias

Answer 13

A systematic limitation in humans ability to think rationally about a situation

Question 14

What is an example of cognitive bias

Answer 14

Gamblers Fallacy
- 50/50 coin lands head 10 times
- Most think must be tails next
- Rationally speaking its still 50/50 not 100% tails

Question 15

What are the 4 cognitive biases

Answer 15

• Rule of thumb
• Anchoring
• Availability bias
• Social Norms

Question 16

What is rule of thumb - cognitive biases

Answer 16

A mental shortcut which enables fast computation of a decision
- it’s the thinking version of human reflexes

Question 17

What is an example of the rule of thumb -cognitive biases

Answer 17

How much to save?
-should depend on income, taxes the future –> RoT: save 10% of income

Question 18

Define anchoring - cognitive biases

Answer 18

When estimating a value we often anchor our estimate upon a value we have seen previously

Question 19

Example of anchoring - cognitive biases

Answer 19

2 people guessing the height of the same building
1st person is asked is it taller than 180ft
–> mean answer guessed 282ft - anchor was much lower
2nd person is asked if it’s taller than 800ft - anchor was much higher
–> mean answer guessed 920ft

Question 20

What does the example of anchoring show?

Answer 20

Shows that anchoring has many economic implications such as does the amount we are willing to pay depend on anchoring,

1 e.g) seller shows a car offers the buyer for 5 grand, the buyer offers £4.5k
2 e.g) shows same car offers to buyer for 6 grand, buyer offers £5.5k

Question 21

Define the Availability Bias - cognitive biases

Answer 21

Is a mental shortcut that relies on immediate examples that come to a given person’s mind when evaluating a specific topic, concept, method or decision.

Question 22

How does the availability bias work

Answer 22

Humans often overestimate the probability of an event they can easily recall examples of.

Question 23

example of availability bias

Answer 23

• People often overestimate the probability of plane crashes
  –> Plane crashes tend to be heavily publicised and memorable
  —-> Introduces an irrational fear of flying

Question 24

Define social norms

Answer 24

Humans are influenced by the opinions of others. A society wide understanding that specific actions or views are either to be encouraged and discouraged.

Question 25

Example of social norms

Answer 25

UK government runs drink-driving adverts at Christmas, that focus on the social impacts that it has. this creates a social norm that drink driving is very discouraged and humans that do so would be very judged by others.