Behavioural Ecomnomics Flashcards
Definition of Rational economic decision making
Economic decisions are based on logical decisions
Economic agents look to maximise the benefits that they receive from a decision
How does the hypothetical man think
Rationality - behaves rationally
Utility - aims to maximise personal satisfaction(utility)
Perfect knowledge - has perfect knowledge (benefit and cost)
Self interest - acts solely on self interest
What does economic incentives mean
A cost or benefit that influences economic agents to act in a certain way the incentives are often but not necessarily financial
Definition of cost
A sacrifice made when making a decision which van be financial but could be other things such as time
Definition of benefit
The utility or welfare received from making a decision
Definition of utility and types
The measure of satisfaction or happiness gained from the consumption of a good or service
Total utility: the aggregate sum of satisfaction gained from the consumption of a certain number of goods + service
Marginal utility: the additional satisfaction gained from consuming an extra unit of a good or service
What is the outline of the law of diminishing Goods
As the consumption of a good increases each additional unit produces less total utility than the item before this is known as the hypothesis of diminishing marginal utility
The first item should always be the most utility in theory
What are the assumptions of the utility theory
The utility theory assumes that consumers choose the basket of goods and services that will maximise their total utility
(They are subject to the constraints imposed on them by there income)
We also assume an individual prepared to pay the price given for a good must want it more then someone who isn’t willing to pay for the price for that good
Satisfaction from a good is determined by the amount payed
Definition of marginal benefit
Additional satisfaction or utility that an individual gains from consuming additional units of a good
Definition of marginal cost
Additional cost incurred by a firm producing an extra unit, or an individual buying an extra unit
The importance of information
To make rational decision we need to break aware of all facts
The mode; of perfect competition assumes that economic agents have perfect information about products price and factor price
In the absence of good quality information decisions are made with incorrect knowledge of facts
Definition of perfect information
All economic agents know all the associated costs + benefit of all products both present + future
This allows right decisions
Imperfect information definition
The information needed for an economic decision may be incomplete or asymmetric leading to sub optimal decisions
This leads to market failure
Definition of symmetric information
Occurs when both the buyer and seller have equal and well informed information of the good or services and the price in the market
Definition of asymmetric information
When either buyer or seller has more information than the other party in a situation or transaction
Definition of moral hazard
Economic agents have incentives to alter there behaviour when another economic agent bears the cost if the decision is bad
Definition of adverse selection
This occurs when a buyer has better knowledge/ information than sellers and can distort the usual market process
What does a rational consumer do to maximise utility
Rational consumers calculated marginal cost and benefit of a purchase
If the marginal cost is greater than the marginal benefit the consumer will not purchase another one of the product
If the MC < MB the consumer with purchase the product
When the MC = MB it is the optimum number to buy this maximises the net utility
The consumer will equate MB + MC across all purchasing decisions
What are issues with utility
Most goods we buy we may not know the exact utility it has
Once we have used a product or experienced it this can lead to consumers making poor decisions
when purchasing goods + service therefore not maximising utility
Defention of Decision utility
Is inferred from choices and used to explain why we make the choices we do
Defention of experience utility
Refers to the experience received from an outcome of a decision we have made
What else effects the rational consumer
Perfect information - has perfect knowledge
Rational behaviour - behaves rationally
Incentives - reacted to incentives to produce self interest
Maximising behaviour/ satisfactory behaviour - maximise personally satisfaction + happiness(utility)
PRIM
What is chore beliefs
Computational skills
Habit
Others
Risk adverse
Ethics
Beliefs
What are computational skills in chore beliefs
Decision making is often influenced by weak computational skills
Rational decision may not be taken because many individuals are unable to calculate possible values of outcomes
What is habit in chore belies
Decision making is often based on habit
Certain decisions become routine
What is others in chore beliefs
Peoples behaviour is influenced by other people
Individuals are affected by watching/copying other people and need for approval
What is risk adverse in chore beliefs
People are adverse to risk they are more inclined to take decisions to avoid loss rather then make gains
What are ethics in CHORE
Ethics + self expectations influence people’s behaviour each person has there own set of values + responsibilities which will influence their decisions are given situation people can be altruistic + want to do the right thing decisions are often influenced by ethical rather than financial factors
What is belief
People need to believe that their decision will be effective people may not make decisions if they do not believe they will be influenced
What is satisficing
Making acceptable but not optimal decisions
Why are consumers not be completely rational
Cognitive limits
Rule of thumb
3 main restrictions in rational economic decisions
The individuals inability to process + evaluate information
The limited time available for many decisions
The lack of information available
What is bounded rationality
Where individuals ability to make a rational decision is restricted by factors such as individuals inability to process + evaluate information
limited time in which to make the decision + imperfect information
What is satisficing
Is accepting an outcome that doesn’t maximise utility but provides a reasonable level of satisfaction
What is bounded self control
Means the individual may not make rational decisions even when they are aware of there irrational decisions because they lack self control
This could be making decisions based on short term utility at the expense of long term utility
What do economists recognise about bounded self control
It can lead to development of approaches that help improve social welfare
What is the bias decision making
A situation in which individuals tend towards a particular preference
The decisions are therefore unlikely to be purely rational
Despite the individual thinking they are weighing up the pros + cons of a decision
What is heuristics (rule of thumb) and examples
A heuristics is a mental short cut which allows us to make decisions efficiently + quickly
It is broadly accurate guide which takes practical experiences into account when making decisions rather then theory
Buying a new phone because it must be technically better then the one before
What is system 1 thinking
Thinking fast (intuitive , immediate , subconscious and automatic)
Short-cuts are made in order to make decisions
What is system 2 thinking
Thinking is slower (rigorous,methodical, controlled, deliberate, effortful and conscious)
It is more rational method that considers as much evidence as possible
What is anchoring
Anchoring is based on data
This is the tendency of individuals to rely on particular pieces of information
Especially in situations where they lack knowledge or experience
It is particular or of priming effect whereby initial exposure to a number
Serves as a reference point + influences subsequent judgment
What is availability
Availability is based on experiences
When information is at the forefront of your mind it can overshadow other relevant information
This occurs because people overestimate the likelihood of something happening
Because a similar event has either happened recently
Because we feel emotional about previous similar situation
What are social norms
Recognises the influences of others upon individuals decisions making
Our day to day behaviour in market is influenced by social Norma’s norms which have become accepted by society may be shunned if not followed
Definition of altruism
Is the selflessness concerned for the well being of others where you are not influenced by consideration of personal advantage
Definition of fairness
Is the notion of what is right this can lead to people making a decision that doesn’t necessarily increase their own personal welfare or utility
Peoples sense of fairness leads to irrational decision making
Definition of loss aversion
Refers to peoples preference to avoid losing compared to gaining the equivalent amount of it is the idea that people feel losses much more then gain
What is choice architecture
How choices can be influenced by the way which the various options are presented to the decision maker
Why does the government use choice architecture
It is used in an attempt to achieve what they perceive to be more socially desirable outcome
What are the forms of choice architecture
Reducing choice overload
Overcoming bias against long term factors
Using measures that are easily understood
The way the choice is presented
What is reducing overload
It occurs when individuals cannot effectively process all the information needed to make choices
What is overcoming bias against long term factors in choice architecture
Individuals tend to underestimate the importance of long term factors when making decisions
What is making measures easy to understand
Comparing energy supplies in terms of monthly billing rather then kilowatt hours of energy
How are choices presented
Default
Mandated
Restricted
What is a default choice
A decision where an individual takes no action
What is restricted choice
When an individual can only select from a limited range of options
What is a mandated choice
Occurs when people are required by law to make certain decision
What is farming
The tendency for people to be influenced by the context in which the choices are presented when making decisions
How choices are formed
Including words used
Affect the choices people make
What are nudges
Ways of influencing individuals choices in a particular decision/direction but without removing their freedom of choice
What is libertarian paternalism
Is the idea that it s both possible + legitimate for private + public instructions to affect behaviour while also respecting the freedom of choice
What are some of Thales findings about the economic policy
Critics of the use of nudges and choice architecture asserts that they are manipulative and interfere with an individuals freedom of choice
People are always influenced by the context in which decisions are made complete freedom of choice isn’t always possible
Thaler + sunstien argue that since people are unlikely to have complete information , unlimited cognitive ability and unrestrained will power
They will inevitably make sub optimal choices and so using M nudges can improve people’s well being
Advantages of behavioural economics policies
There are very little costs associated with many behavioural economics policies ( so need to subsidies )
Doesn’t effect those being ‘nudged’ financially so could be deemed fairer to alternative polices
Such policies make it easy to change behaviour - little effort required of person being ‘nudged’ (default choice) opting out
Changing default can have advantage of becoming a social norm this can make it attractive for individuals to change their behaviour therefore lead to a long lasting
behaviours in line with what is believed to be socially beneficial
Once subsidy of tax is taken away does not effect income
What are disadvantages of behavioural economics policies
Behavioural economics may encourage governments to become too paternalistic in their policies attempting to nudge behaviour
Do policy makers make better decisions that individuals
Policy makers may also have bounded rationality suffer from biases + not have perfect computational skills
Do nudges interfere with the freedom of choice
Behavioural economics focuses too heavily on peoples vulnerability to fall for fallacies and their
psychological biases - it can give the impression that consumers are dumb
But in fact consumers using well - practiced rule of thumb might be operating rational ways
There are limits to nudge theory it may be useful in changing minor behaviourist but no it in deep rooted psychological problems such as alcoholism + street violence
Conventional policy’s interventions such as taxes, subsidies + regulation are often just as effective as nudges because price remains an important determinant of choices in the market
