behavioral economics Flashcards
behavioral economics
A new field of study that seeks to incorporate psychology into economics to enhance our understanding of consumer behaviour.
Interested in how people actually act rather than how a theoretical model says they act.
Behavioural economists consider 3 insights into human decision making which contradict the traditional economic viewpoint:
1.Bounded rationality
2. Bounded will power
3. Bounded self interest
Bounded rationality - Good enough
suggests ability to make rational decisions compromised by the:
• Available information
Complexity of the decision
• The brains cognitive limitations
• Time constraints
Because of this, decision aren’t always the most rational or utility maximised, rather they are good enough.
Factors to explain why rational decision aren’t always made-Overconfidence bias
when people take on too much debt, a decision that they often come to regret.
For example, market investors can be prone to overconfidence bias that they can predict when the next crash would happen.
Factors to explain why rational decision aren’t always made- Herd behavior-
consumers follow the crowd, hoping that crowd knows more than them.
For example, if a group ot people are investing in Bitcoin, others start investing as well.
factors to explain why rational decision aren’t always made-Anchoring effect
is where consumers judgements are affected by some arbitrary starting value.
purchasing a new car is expensive. The price of a new car acts as a the ‘anchor’ or reference point which makes all the extras such as paint protection and extended warranties that salesperson try to convince people to buy seem relatively cheap and hence, consumers walk out of car showrooms purchasing all the extras rather than just a car.
Factors to explain why rational decision aren’t always made -status quo bias-
is the tendency for consumers to stick with a particular choice even though the decision to do so is no longer in their self interest.
For example, reluctant to change electricity provider even when you there are better options available.
Factors to explain why rational decision aren’t always made
factors to explain why rational decision aren’t always made - Vividness
is when consumers place too much weight on a small number of vivid observations.
For example, to buy a new phone, you read consumer reviews of 1000 people, who say the particular brand phone is good but you later run into a friend who says that phone is no good. Even though the sample size only increased by 1000 to 1001, you will place more trust on the friend.
factors to explain why rational decision aren’t always made -Framing bias
The way the options are framed can affect the choices that people make and lead to irrational decisions.
For example, To encourage people to donate a kidney
A: Is it morally acceptable to pay people to ‘donate’ a kidney?
B: Do you know that lives could be saved by paying people to ‘donate’ a kidney?
bounded will power
This is the idea that consumers don’t posses absolute self control over their choices.
They often succumb to urges, are emotional in their decision making and impulsive.
This can lead to poor decisions often as a result of present bias, which is where people over value present and under value future.
For example, people spend too much on credit, travelling and do not save for retirement.
bounded self interest
States that consumers care about fairness and aren’t always driven by narrow self interest in order to maximise their personal benefit.
The idea of self interest explains that consumers are driven by a sense of fairness and will reject any proposals that treat them unfairly even if it is contrary to their self interest.
For example, when the business earns profit that should be equally shared among the workers to motivate them. If this is not done, workers could potentially punish the business through reduced effort or industrial disputation.
the differnce between traditional and behvaioral economics
Traditional consumer:
They have ordered preferences (satisfy needs before wants)
Maximise utility
Are fully informed
Acts rationally
Whereas the modern consumer may be influenced by internal and external factors which may lead to less rational decisions being made overall.
diminishing marginal utility
Refers to the concept that with each good or service consumed, we feel less satisfaction overall.
- Therefore consumers benefit from ‘mixing it up’ to maintain their satisfaction over time.
strategy the government uses to reduce alcohol consumption, tabaco consumption
strategy the government has used to benefit the public health sector
