Chapter 2

Question 1

What is traditional economic theory?

Answer 1

Traditional economic theory assumes that consumers always act rationally, seeking to maximise satisfaction

Question 2

What is utility?

Answer 2

The amount of satisfaction or benefit that a consumer gains from consuming a good or service

Question 3

What is a description of a rational consumer?

Answer 3

An assumption of traditional economic theory that consumers act in such a way to maximise utility when spending money on a good or service

Question 4

What is marginal utility?

Answer 4

The satisfaction gained from consuming an additional unit of a good or service

Question 5

What is the law of diminishing marginal utility?

Answer 5

As individuals consume more units of a good or service, the additional units give successively smaller increases in total satisfaction

Question 6

How does the law of diminishing marginal utility effect the individual demand curve?

Answer 6

As marginal utility declines, the price the consumer is willing to pay for additional units decreases

Question 7

What is imperfect information?

Answer 7

The fact that consumers rarely possess all the information required to make fully informed decisions

Question 8

What is the effect of imperfect information?

Answer 8

It causes consumers to not always act rationally

Question 9

Name three sources of imperfect information:

Answer 9

Economic agents may know more or less than other parties in a transaction

Information can be presented in such a way that excludes some people e.g technical or legal jargon

There could be costs involved of acquiring some information

Question 10

What is asymmetric information?

Answer 10

A source of information failure where one economic agent knows more than another, giving them more power in a market transaction

Question 11

What are two examples of markets that contain asymmetric information?

Answer 11

The market for so-called “lemons” where a second-hand car salesman knows more about the quality of the car that he is selling than the buyer

Where and individual may know more about their credit-worthiness than the bank from which they are trying to secure a loan from

Question 12

What are the results of asymmetric information?

Answer 12

Market failure.

Uncertainty also leads to a lack of trust between economic agents, meaning mutually beneficial exchange does not always occur

Question 13

What is behavioural economic theory?

Answer 13

Behavioural economics recognises the social, moral and psychological factors that determine the power of economic agents

Question 14

What are the aspects of behavioural economic theory?

Answer 14

Bounded rationality

Bounded self-control

Rules of thumb

Anchoring

Availability bias

Social norms

Altruism and fairness

Question 15

What is bounded rationality and it’s factors?

Answer 15

When people try to act rationally but are restricted by factors such as:

The human mind having limited ability to process information

The available information being incomplete

Time to make decisions is limited

Question 16

What is bounded self-control?

Answer 16

When individuals lack the self-discipline to see their rational good intentions through e.g regular gym attendance and giving up smoking

Question 17

What are the results of bounded rationality?

Answer 17

Individuals end up satisficing, or accepting sub-optimal outcomes

Question 18

What is meant by “rules of thumb”?

Answer 18

Thinking shortcuts, that individuals use to make decisions in order to save time and effort

Question 19

What is anchoring?

Answer 19

The tendency of individuals to rely on particular pieces of information when making choices between different goods and services e.g a consumer looking at car insurance quotes, focusing on price as the key point of comparison rather than the features and excesses

Question 20

What is the availability bias?

Answer 20

When people make judgements about the probability of events by recalling recent instances e.g recalling a family member who lost their family savings in the last recession, therefore discouraging personal savings

Question 21

What is a social norm?

Answer 21

When individuals are influenced by others when making decisions

Question 22

What is altruism and fairness?

Answer 22

Individuals are motivated to do the right thing, even if this means paying more for a good or service

Question 23

What is choice architecture?

Answer 23

Influencing consumer choices by the way choices are presented

Question 24

What are the forms of choice architecture?

Answer 24

Framing

Nudges

Default choice

Mandated choice

Restricted choice

Question 25

What is framing?

Answer 25

Influencing consumer choices by the way words and numbers are used e.g “less that £3 a day” sounds a lot better than “£1000 per year”

Question 26

What are nudges?

Answer 26

Influencing consumer behaviour via the use of gentle suggestions and positive reinforcement

Question 27

What are default choices?

Answer 27

Influencing consumer behaviour by setting socially desirable choices as default options e.g the case for organ donation is opt in and so individuals would actively have to opt out

Question 28

What are mandated choices?

Answer 28

Where people are legally required to make a choice e.g many countries require a decision to be made about organ donation as a part of their driving licence application

Question 29

What is a restricted choice?

Answer 29

Giving consumers a limited number of options when making a choice. Effective when there’s too much choice e.g energy bills and pensions