4.2 Behavioural economics Flashcards
What is behavioural econoimcs
Focuses on finding examples where real-life economic agents do not act like homo economicus
3 examples where humans don’t act like homo economicus and make perfect decisions
1) Bounded Rationality and self-control
2) Systematic biases
3) Altruism
Define bounded rationality
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
What 3 things make up the bounded rationality theory
1) Computation
2) Imperfect Information
3) Time
Define computation in bounded rationality theory
Humans cannot perform exact complex calculations
Define Imperfect Information in bounded rationality theory
Humans don’t have access to all relevant information, most markets lack perfect information
Define Time in the bounded rationality theory
Humans have to make decisions on the spot and cannot take time to consider the costs and benefits
Who created the theory of bounded rationality
Herbert Simon, said that humans do try to make the best decision, but often accept near enough solutions
What does bounded rationality mean split?
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.
What is bounded self control
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.
What is an example of bounded self control
Jenny going the gym
What does the example of bounded self control show
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
Define cognitive Bias
A systematic limitation in humans ability to think rationally about a situation
What is an example of cognitive bias
Gamblers Fallacy
- 50/50 coin lands head 10 times
- Most think must be tails next
- Rationally speaking its still 50/50 not 100% tails
What are the 4 cognitive biases
- Rule of thumb
- Anchoring
- Availability bias
- Social Norms
What is rule of thumb - cognitive biases
A mental shortcut which enables fast computation of a decision
- it’s the thinking version of human reflexes
What is an example of the rule of thumb -cognitive biases
How much to save?
-should depend on income, taxes the future –> RoT: save 10% of income
Define anchoring - cognitive biases
When estimating a value we often anchor our estimate upon a value we have seen previously
Example of anchoring - cognitive biases
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
What does the example of anchoring show?
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
Define the Availability Bias - cognitive biases
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.
How does the availability bias work
Humans often overestimate the probability of an event they can easily recall examples of.
example of availability bias
- People often overestimate the probability of plane crashes
–> Plane crashes tend to be heavily publicised and memorable
—-> Introduces an irrational fear of flying
Define social norms
Humans are influenced by the opinions of others. A society wide understanding that specific actions or views are either to be encouraged and discouraged.
Example of social norms
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.
