Behavioral Economics Flashcards
Rationality & Self-Interest:
(LIST KEY POINTS)
Rationality & Self-Interest:
Consumers will only buy for needs or wants that interest or benefit them.
They are only concerned with maximising utility (completely satisfying a need/want)
Consumers carefully weigh up the expected costs and benefits of each and every decision.
Are not influenced by those around them
Are never instinctive/impulsive when making a purchase.
Ordered preferences:
Ordered preferences:
Consumers are able to rank their preferences (of needs & wants) and make choices based on these rankings in order to maximise their utility.
There is an assumption that preferences remain consistent over time.=
Informed decision-making:
(DEFINE)
Informed decision-making:
Consumers have access to relevant and accurate information to make rational decisions.
Marginal benefits from consumption:
(DIMINISHING LAW OF MARGINAL UTILITY
EG??
Marginal benefits from consumption:
Consumers are aware of the law of diminishing marginal utility and as such will be rational in consumption.
The law of diminishing marginal utility:
Each additional unit of a good or service that is
consumed generates less utility than the previous one.
Eg; The first ice cold drink on a hot day has highest utility
Every drink after reduces utility until no utility is met, or
even goes into negative
IS IT OUTDATED?
Outdated?
As you can see, the traditional view of consumers is being challenged and is considered by some to be outdated.
Challenging the Traditional economic viewpoint of consumers? LIST AND GENERALLY DESCRIBE (5)
Challenging the Traditional economic viewpoint of consumers
Rationality:
What about impulsive?
Ordered preferences:
Informed decision making:
Marginal benefits from consumption:
Traditional vs Behavioural viewpoints
(DESCRIBE AND CATAGORISE EACH)
Traditional vs Behavioural viewpoints
Traditional economics suggests
Behavioural economics suggests
Rationality: people make rational decisions
Bounded Rationality: People often lack enough analytical skills and academic ability to be able to weigh up all the information, and/or have biases such as status quo/present/procrastination bias
Informed Decision Making; Ordered Preferences: people have perfect knowledge
Bounded Rationality: people often have fake or incomplete information and/or influenced by narrative fallacy, AI algorithms, anchoring and/or framing
Rationality: people do not act impulsively
Bounded Willpower: people are influenced by others’ opinions, and/or have biases such as herd/vividness bias.
Self Interest; Marginal Benefits: people only aim to maximise gains or utility
Bounded Self-interest: people care about others, have an aversion to risk, and/or have biases such as overconfidence/control bias.
How do consumers “really behave”?
(WHAT DOES THIS GO AGAINST) (3)
How do consumers “really behave”?
Behavioural economists have developed 3 insights into human economic decision-making:
Bounded rationality
Bounded will power, and
Bounded self interest
Each of the above go against some of the assumptions of the traditional economic view of consumers.
DESCRIBE BOUNDED RATIONALITY
Bounded rationality
Bounded rationality: The idea that consumers’ ability to make rational decisions is compromised by the availability of information, the complexity of the decision, the brain’s cognitive limitations and time constraints
Due to limited brainpower and time, people will not be able to consider every possible option every time a new decision is required
Consumers will often do as best as they think they can, and are happy to settle for ‘good enough’
Bounded rationality is impacted by the following biases/cognitive limitations:
and define briefly
Bounded rationality: Biases and Decision-making errors
Bounded rationality is impacted by the following biases/cognitive limitations:
Overconfidence bias
Control bias
Vividness
Status quo bias
Present bias
Procrastination bias
Anchoring effect
Herd behaviour
Framing bias
Risk aversion bias
Narrative Fallacy
Nudging
Artificial Intelligence
Overconfidence bias
Overconfidence bias
This is the idea that consumers overestimate their ability to make good decisions and therefore make irrational decisions
Overconfidence bias due to Control bias
Overconfidence bias due to Control bias
The ‘Illusion of control bias’ contributes to the ‘Overconfidence bias’.
It is the belief that consumers can control or influence future outcomes. Eg wearing lucky socks, buying lottery tickets with particular numbers, https://thedecisionlab.com/biases/illusion-of-control
Share: What control biases do you or someone
you know have in order to control or influence outcomes?
Vividness
Vividness
Consumers can place too much weight on a small number of vivid observations.
When making a decision, they will listen to
their friend’s opinion even though it
contradicts everything else they have read on
the topic from independent sources.
How many times have you made decisions
based on friends opinion, waiter recommendations, or
even to a friendly sales rep?
scenario - js justify your choice xx
Which would you choose?
Imagine that you have just moved to a new city and are getting your driver’s license sorted out. The application form asks about your organ donation preference when you die.
The default in this city is that you donate your organs when you die. Do you:
Leave it as it is, i.e. donate
Change it to not donate
Status quo bias
Status quo bias
Consumers tend to stick with a particular default choice even though the decision to do so is not in their self-interest.
Status quo bias can also be explained by
‘present bias’ (aka #YOLO),
‘procrastination bias’ (aka #Ceebs)
Transaction costs (commissions, delivery/transfer fees, taxes etc) and complicated processes are often used to encourage procrastination.
Anchoring effect - who/how do people use it?????
Anchoring effect
This is where consumers’ judgements are affected by some arbitrary starting value/reference point or ‘anchor’
This is seen a lot in real estate auctions
where the price usually exceeds the price
range quoted
You’ll also see products quoted with the basic model price,
when in reality add-ons that make it usable costs more.
Look out for the words “starting at…” or “..only..”
Anchoring effect example
Anchoring effect example
You see a cool jacket on sale at a shop. You try negotiating with the salesperson on the price of the jacket, and they quote you the first price of £50. You think this is a fair price and buy it.
In this example, the salesperson would’ve accepted lower, but you thought about how much lower £50 was in comparison to the original price that you forgot about negotiating an even lower price and bought it.
Herd behaviour
Herd behaviour
When confronted by decisions where the outcomes are highly unpredictable, people often ‘follow the herd’.
Following the herd can be a ‘mental shortcut’ as people don’t always have access to all the information.
SCENARIO js JUSTIFY your choice xx
Scenario 1: Pandemic Drug Version 1
A pandemic has ravaged the country. You have access to 2 experimental vaccines and 600 sick people to test it on. You can only use one.
Program A: 200 people will be saved.
Program B: There is a 1/3 chance that all 600 people will be saved
Which would you choose?
Framing Effect
its an eg
Framing Effect
Program C
400 people will die..
..which means 200 will be saved
Program D
There is a 1/3 chance that non one will die
.. so there is a 1/3 chance that people will be saved.. just like Program B!
=> 200 will be saved
Program A
200 people will be saved
Program B
There is a 1/3 chance that 600 people will be saved
600 * (1/3) = 200
Same question, yet people make very different decisions!
describe: Framing bias
Framing bias
Options or proposals are put forward in a particular way that affect the choices people make.
How often do you see the facts beyond the framing?
Risk aversion bias
define + eg
Risk aversion bias
People tend to avoid “losses” over “gains”
Example, presented with 2 envelopes. 1 has $100, the other none.
You are offered a choice of one of the envelopes (1 in 2 chance of winning), or receive $50 for not choosing and walk away. Which one would you take?
Habitual Bias
(define + eg )
Habitual Bias
Habitual behaviour includes decisions following a regular routine of behaviours
Once habits are formed, they are often difficult to change and therefore businesses will often try to exploit them
Example: you drink coffee every morning at your local shop instead of having it at home. Although this might not be the most rational decision if you’re trying to save money, you will still do it because it’s a habit.
Narrative Fallacy
(define + eg)
Narrative Fallacy
Being persuaded by how something is presented or told (story), rather than the rational facts itself.
Examples: Get rich schemes, scams, media coverage..
Research some scams and cons online (eg travel scams, spin doctoring). Discuss in class how and why you think they work
Nudging
(define + eg)
Nudging
Nudging: is a gentle strategy that “steers people” into towards a desired behaviour or outcome, and it must be in their own self-interest
What goods do you tend to see at supermarket checkouts? What about lower shelves?
How does notifications influence behaviour?
What about free vouchers?
Artificial Intelligence
(define + think of pros and cons)
Artificial Intelligence
Social media algorithms using machine learning and data analytics allow sites and apps to collect information about you and predict what your next behaviour or purchase.
They then respond with personalized ads, notifications, and suggestions.
Pros: Can be assistive and helpful
Cons: Can feel intrusive, encourage impulse buys, privacy breaches, suggestion errors
Bounded rationality:
(list types)
Bounded rationality: Mitigating Biases and Decision-making errors activity
Overconfidence bias
Control bias
Vividness
Status quo bias
Present bias
Procrastination bias
Anchoring effect
Herd behaviour
Framing bias
Risk aversion bias
Narrative Fallacy
Nudging
Artificial Intelligence
Bounded willpower
(describe + what is needed sometimes to challenge)
Bounded willpower
Bounded willpower: The idea that consumers do not possess absolute self-control when confronted with choices. People can be emotional or impulsive.
Intervention is sometimes needed. Eg: enforcing retirement savings through compulsory Superannuation program.
Bounded willpower
(contributors?)
Bounded willpower
Behavioural economists attribute these self-control problems to ‘present bias’- people tend to value the present over the future. Eg; “Buy Now, Pay later”, #YOLO
Bounded willpower
(describe + think of markets taking advantage of this)
Bounded willpower
Some consumers may have poor self-control and may succumb to junk food in the midst of a diet or they may procrastinate/give up on tasks
Discuss: How might a marketer take advantage of this?
Ethics (define + consider impact)
Ethics
Ethics: The moral principles that guide a person’s behaviour
Ethical considerations may influence a person’s consumption. For example, one may decide to purchase certain goods and services that support fair wages or animal welfare, despite the premium price.
Discuss: Can you think of other products in which ethics might play a part?
Bounded self-interest
(define)
Bounded self-interest
Bounded self-interest: The idea that consumers care about fairness and aren’t always driven by self-interest in order to maximise their personal benefit
From time to time, people are willing to sacrifice
their own interest to benefit others.
Strategies used by producers/businesses
(4)
Strategies used by producers/businesses
Nudging
Multi-branding
Marketing (5 Ps)
Product, price, people, place, promotion
Nudging
(list strats)
Nudging
Signs, prompts, guides, product placement (supermarket layouts)
Reviews/star ratings (herd/vividness)
Anchoring, framing, suggesting (“the best for you”)
Time/quantity-limited discounts/availability pop ups (creating urgency = impulse)
Limits on purchases/limited editions/scarcity/members only (creating exclusivity = desire)
Nudging
(opt in and opt out)
describe + eg
Nudging strategies
Opt in vs opt out
For example, automatically charging passengers on budget airlines for meals—and asking them to opt out (usually through complicated means) rather than offering them the chance to opt in
Or free 1 month subscriptions that then charges for each month afterwards unless you actively opt out.
This is based on the “procrastination bias” where too much effort required to change results in no change at all (or counting on you forgetting to do so)
Multibranding
define + think of companies that do this
Multibranding
Where one company owns others with different names to produce various and similar products.
L’Oréal
Nestle
Volkswagen
Meta
Why multibranding?
Why multibranding?
Hold more supermarket space
Use its brand reputation to boost
products made in other
markets
Appeal to audiences who like novelty
or trying new things
reach a different audience
create a luxury line to appeal to a
consumer willing to pay more.
Other strategies businesses can use
Other strategies
Building brand identity/reputation
eg Apple reimaged to be cool, trendy)
Building brand loyalty
R&D (eg the iPhone story)
Social responsibility (Fairtrade)
Customer service (quality, speed)
Price
Marketing
(define + effects)
Marketing
A key component of all businesses which engages in activities based around bringing the customer to the business.
Involved with market research, product development, price setting, promotion and deciding on most efficient distribution methods/techniques.
list The 5Ps of marketing
The 5Ps of marketing
Product
Price
People
Place
Promotion
Intervention Strategies
(3)
Intervention Strategies
Incentives
Disincentives
Educational
Incentives
(define)
Incentives
A benefit, reward or cost that motivates economic agents to make specific decisions or act in a particular way
Externalities (describe + what does it encourage)
Externalities
Governments use their control over the tax system and considerable spending power to create both positive and negative incentives to help ensure that consumers make the ‘right choices’
Encourages consumption of goods and services with positive externalities and limiting those with negative externalities.
Externalities = Effects on others, not just consumer
Positive incentives to influence behaviour
Positive incentives to influence behaviour
Governments (and businesses) use incentives to influence behaviour.
Positive incentives: encourage people to make certain decisions - the carrot (eg; subsidies, discounts, loyalty reward systems)
Negative incentives to influence behaviour
Negative incentives to influence behaviour
Negative incentives: discourage people from making decisions - the stick (eg fines, taxes)
How much do you think a $20k Honda Civic costs in Singapore?
Educational Interventions
Educational Interventions
Marketing/Advertising
List ad campaigns you have seen run by the government
Activity 1: Imagine you are working for the government for a digital detox health campaign.
think of pos and neg incentives to influence consumers!!
Positive and negative incentives to influence behaviour
Activity 1: Imagine you are working for the government for a digital detox health campaign.
In groups come up with a positive and negative incentives campaign that will influence consumers towards the desired behaviour.
