Behavioural Economics Flashcards
Term and definitions
What are framing effects? give an example
Framing Effects are the impact on rational decision making of the consumer caused by the way the same information or EV of a good is packaged. For example, two identical yogurts could be packaged differently, one labelled 95% fat free and the other 5% fat. Consumers may choose the 95% fat free labelled yougurt more than the other because the way the information is converyed makes it seem like that yogurt is healthier
what are Anchoring effects? give an example
Anchoring effects are the impact on the rational decision making of the consumer because individuals tend to rely on prior pieces of information which are completely irrelevant to the outcome. the initial piece of information is known as the ‘anchor’. for example, if shopping for a car and the first car price you see is 20K, then you would comapre every following car to that price despite the fact that the value of the other cars has no relevance to the price of the first car and whether you are getting a good deal depends on the price given by the seller compared to the actual market value of the car (good).
What is the Too much choice fallacy? give an example
Too much choice is when the consumer is faced with too many choices and is overhwelmed and cannot come to a decision. this is contradictory to rational consumer theory where more choice is deemed better.
what is the Law of small numbers?
The law of small numbers is that people tend to be overconfident in trends they find in small samples and apply these trends to the general population which causes biased and unrational decision making. and example of this would be a stock broker investing into a stock because it has displayed a strong positive trend over the last 3 months, thinking it will continue to do so over the long run
What is the sunk costs fallacy?
The money someone has paid for something becomes ‘sunk’ and these costs are not recoverable. therefore future decisions should be independent of these costs, however, in most cases they are not because a seller wants to recover the cost, whereas buyers do not care about this information and only care about the price vs the market value
What is Loss aversion?
In exepcted utility theory we made the assumption that people only cared about their net wealth in various outcomes. this is known as asset integration hypothesis. in reality however people receive less utility from winning a gamble of x amount of money then the utility they lose from losing x amount of money. this leads to a revised version of expected utility called prospect theory.
What is prospect theory?
an alternative theory on expected utility which takes loss aversion into consideration.
What is time discounting? what are the issues around it?
TIme discounting is when an individual values amount of money x* more now then in the future, and the amount they value it in the future is discounted by sigma. This is called exponential time discounting and is the time discounting associated with classical consumer theory. However it does not accurately convey how consumers discount the far future.
What is the alternative to exponential time discounting? what is it? why is it better?
Hyperbolic time discounting. The value of £1 in n months from now is perceived as 1/(1+nk) where k is the discounting article dependent on the consumer and k > 0. It is better than exponential time discounting because it allows economists to model how consumers value the price of something in the far future more accurately.
what are Self-control issues?
The rational choice model assumes that your preferences are know to you and do not change over time but in reality this may not always be true.
