Behavioural economics Flashcards
What does traditional economics believe about consumer behaviour
That consumers are always rational and look to maximise their utility by weighing up the costs and benefits
What does behavioural economics argue about consumer behaviour
- That emotional, social and psychological factors heavily influence decision making
- This is because consumers are not always rational and looking to maximise utility as they have bounded rationality and bounded self control
What are the reasons for bounded rationality
- Consumers may not have the time to weigh up costs and benefits and make a utility maximising decision
- Consumers are too overwhelmed to do cost-benefit analysis as there is too much choice
- There may be information failure in the market, meaning consumers don’t know the costs and benefits
Why does bounded self control reduce rationality
People may know all the costs and benefits and have rationality but don’t have the self control to make utility maximising decisions
e.g. consumers know sugary drinks are bad but still drink them
Why do consumers use heuristics (rules of thumb)
- Bounded rationality and self control increases consumer’s reliance on shortcuts to make decisions efficiently
e.g. because they don’t have time or information
How do heuristics lead to a satisficing outcome
Taking shortcuts means utility may be sacrificed but a satisfactory outcome will be achieved
What are the reasons for bounded rationality and bounded self control
Emotional, social and psychological factors known as cognitive biases
What is anchoring bias, giving an example
When we make judgements using single pieces of information which could be useful or misleading. This is a type of heuristics.
e.g. salesmen shows us the most expensive model first so other models seem cheaper in comparison to the “anchor”
What is social norms bias, giving an example
Our decisions are influenced by rules that society has dictated so our behaviour falls in line with these expectations. This is a type of heuristics.
e.g. tipping at restaurants
What is availability bias, giving 2 examples
We make decisions based on high profile information which is easy to remember, even though they inflate the real probability of it happening. This is a type of heuristics.
e.g. Shark attacks are very rare Australian oceans but because they are always in the news, we think the risk is higher so we decide not to swim there
e.g. If we have a relative who smoked and lived to 90, then we think the risk of smoking is less than it actually is
What is loss aversion bias, giving an example
We don’t like to lose things that we have a value towards. This is a type of heuristics.
e.g. less likely to invest our money in case we lose it, even if the probability is low
What is herd behaviour bias, giving an example
Our decisions are influenced by decisions made by other people. This is a type of heuristics.
e.g. financial markets where people invest in something because everyone else is causing a bubble
What is confirmation bias
We look for evidence that supports our views and ignore evidence that doesn’t when making decision. This is a type of heuristics.
Give an example of when emotional, social and psychological factors are a good thing
Charities as you are giving up utility expecting nothing in return i.e. altruism (which is technically irrational)
What is choice architecture
When we change the way that things are designed and presented to people to influence their decision. This can be used as government intervention.
What is a nudge
Type of choice architecture where we alter people’s behaviour whilst retaining their freedom of choice
e.g. putting fruit at eye level
What is a shove
A type of choice architecture where we alter people’s behaviour by limiting their freedom of choice
e.g. banning junk food
What is framing
A type of choice architecture where we change how choices are presented without altering the actual choices
e.g. Consumers are more likely to buy a gym membership at “£25 a week” instead of “£1300 a year”
What is a default choice
Type of choice architecture where we are automatically making decision unless we choose to opt out
e.g. Making organ donation a default choice unless you opt out has increased donation rates
What is restricted choice
Type of choice architecture where we reduce the number of choices available to make things simple
e.g. giving a few pension options instead of loads will increase take up rate
What is mandated choice
Type of choice architecture where we are forced to make a choice
e.g. forced to say yes or no to organ donation in some countries
What are the disadvantages of using choice architecture to correct market failure
- Unpredictable as they might not work
- Can be costly
- May not be strong enough to overcome deep rooted issues like addiction
What are evaluation points on whether choice architecture policies can correct market failure
- The cost may be greater than the benefit leading to government failure
- Information failure is a bigger reason for irrationality than biases so gov should focus on providing more info
- Policies are not strong enough by themselves but should be used alongside more forceful policies like taxation and regulation
