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IS IT OUTDATED?
Outdated?
As you can see, the traditional view of consumers is being challenged and is considered by some to be outdated.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.
