Behavioural economics (micro) Flashcards
Loss aversion
Loss aversion refers to a behavioural bias where people seem to focus more or weight more on a potential loss more than a potential gain. A loss is more painful to people than an equivalent gain is rewarding to them. People seem to be motivated more by losses than gains of a similar magnitude. In other words, the disutility of losing £20 is greater than the positive utility of gaining £20.
Anchoring
Anchoring is the use of (usually) irrelevant information as a reference point for helping to make an estimate of an unknown piece of information. In other words, people use an “anchor point” of an event or a value that they know in order to make a decision or estimate. Behavioural scientists describe anchoring as a cognitive bias.
Marginal utility
In economics, utility refers to the benefits (satisfaction or happiness) consumers derive from a good, and it can be measured based on individuals’ choices between alternatives or preferences revealed in their willingness to pay. Marginal utility is the change in total utility from consuming an extra unit of a product.
Imperfect infromation
Information failure occurs when people have inaccurate, incomplete, uncertain or misunderstood data and so make potentially ‘wrong’ choices.
Aysmmetric information
refers to when one party in a transaction is in possession of more information than the other. In certain transactions, sellers can take advantage of buyers because asymmetric information exists whereby the seller has more knowledge of the good being sold than the buyer.
market for lemons
The lemons problem refers to the issues that arise regarding the value of an investment or product due to the asymmetric information available to the buyer and seller.
The lemons problem theory was put forward by George A. Akerlof, an economist, who presented his ideas in a research paper titled, “The Market for “Lemons”: Quality Uncertainty and the Market Mechanism.”
The use of “lemon” refers to a slang term for a vehicle that has many problems and defects that negatively impact its utility.
The lemon theory posits that in the used car market, the seller has more information regarding the true value of the vehicle than the buyer. This results in the buyer not wanting to pay more than the average price of the car, even if it is of premium quality. This benefits the seller if the car is a lemon but is a disadvantage if the car is of good quality.
The existence of asymmetrical information is not only apparent in the used car market, but many markets, such as consumer and business products, and investing.
moral hazard
When the party with superior information alters his/her behaviour in such a way that benefits himself while imposing costs on those with inferior information. For example, moral hazard occurs when insured consumers are likely to take greater risks, knowing that a claim will be paid for by their cover. The consumer knows more about his/her intended actions than the producer (e.g. the insurer).
social norms
Our day-to-day behaviour in markets is influenced by prevailing social norms or social customs.
bounded rationality
Bounded rationality is the idea that the cognitive, decision-making capacity of humans cannot be fully rational because of a number of limits that we face. people choose using the information they have available. They can’t make a ‘better’ choice without knowing more. e.g. food label. Too much or too little info, not enough time to make the desicion.
bounded self-control
This concept is closely linked to that of bounded rationality. Rationally, and according to neoclassical economic theory, consumers know when the price of a good/service exceeds the marginal utility they gain from consuming that good/service – in this rational world of homo economicus, consumers stop consuming. In reality, though, there is plenty of evidence to suggest that consumers often do not stop consuming even when it makes sense to stop – think about over-eating, excessive investment in a particular stock or share and so on.
rules of thumb
A rule of thumb is followed when people use heuristics when making decisions. A rule of thumb is a practical principle or guideline that can be used as a rough basis for making decisions or solving problems. Rules of thumb are often based on experience or observations, and they can be useful in situations where exact calculations are not necessary or possible
availability bias
Availability bias is a heuristic whereby people make judgments about the likelihood of an event based on how easily an example, instance, or case comes to mind. It can also happen because we feel emotionally affected by a recent event. Availability bias can lead to people over-estimating the likelihood of an event happening and can lead to a departure from rational decision-making.
altruism
The phenomenon in behavioural science for humans to behave with more kindness and fairness than would be the case if they behaved rationally. The ultimatum gameis a good example of the principle. Altruism is often linked to the concept of inequity aversion i.e. humans do not like unequal outcomes. Whilst this is usually seen as positive, it can also result in a negative outcome e.g. a person being willing to forego a gain / reward if it means that someone else won’t gain an even better reward.
homo-economicus
The term home describes a view of humans as self-interested agents with well-defined preferences who seek optimal, utility-maximizing outcomes. From their daily decisions. Behavioural economists are critical of the concept not least because of the effects of bounded rationality.
Nudge
A nudge is a technique used by choice architects in order to change someone’s behaviour in a very easy and low-cost way, without reducing the number of choices available. We often see it described as “non-enforced compliance”.
