Decision making + Behavioural Economics

Question 1

Assumption of all economic agents (traditional)

Answer 1

Utility Maximisation
The price they are willing to pay is a reflection of marginal utility (Price = Utility)

Question 2

Marginal Utility

Answer 2

The utility gained from consuming an additional unit of a good / service.

Question 3

Total utility

Answer 3

The overall benefit from consuming a good or service

Question 4

The law of diminishing marginal utility

Answer 4

As the quantity of a good/service increases, the marginal utility begins to decrease.

Explains why the demand curve slopes downward

Question 5

Traditionally assumed objective of consumers / firms / Govt.

Answer 5

Consumers - Utility Max.
Firms - Profit Max.
Govt. - Welfare Max.

Question 6

Key assumptions of traditional economics (2)

Answer 6

Economic agents are rational
Economic agents maximise utility

Question 7

Behavioural Economics (Definition)

Answer 7

Challenges the key assumptions of traditional economics and aims to consider social, psychological and emotional factors to understand decision making

Question 8

Assumption of rationality

Answer 8

Economic agents will maximised their utility by considering costs and benefits of alternatives and choosing the most beneficial option

Built on the assumption that economic agents have perfect information.

Question 9

Limitations of rationality

Answer 9

Imperfect / Asymetric information
Time to make the decision
Computation Weakness

Question 10

Bounded Rationality

Answer 10

Rationality is limited when individuals make decisions, and under these limitations, rational individuals will select a decision that is satisfactory rather than optimal.

• Satisficing

Question 11

Bounded Self-control

Answer 11

The idea that we do not have total self-control and that we may be unable to act in a utility maximising way, due to impulses and desires.

Question 12

Hyperbolic discounting

Answer 12

Whereby consumers sacrifice larger rewards in the future for immediate satisfaction.

Question 13

Cognitive Biases (5)

Answer 13

Rules of thumb
Anchoring
Avaliability Bias
Social Norms
Altruism

Question 14

Rules of thumb

Answer 14

Sticking to basic rules/ assumptions rather than fully processing information - resulting in suboptimal decisions being made risking losing beneficial opportunities and utility.

Question 15

Anchoring

Answer 15

Using a separate piece of information as a benchmark for how we should make our decisions, usually in regards to price.

Question 16

Avaliabilty Bias

Answer 16

Using the most readily available, understandable information to base decisions off. For example, an estate agent may show you a bad house for a high price and then take you to a nicer house for a ‘lower price’, however realistically the house is still overpriced.

Question 17

Social Norms

Answer 17

Following societal expectations or tradition despite being irrational to do so. For example, it is not utility maximising to tip at a restaurant, however we do so due to the societal expectation that exists.

Question 18

Altruism

Answer 18

Acting in accordance to the effects to others, overwise acting in a selfless manner. This concept directly contradicts the homo economicus ideal that we are selfish personal utility maximisers.

Question 19

Uses of Behavioural Economics (5)

Answer 19

Default choice
Mandated choice
Restricted choice
Nudges
Framing

Question 20

Default Choice

Answer 20

The option which will likely bring the economic agent the most utility will be selected by default - ie. need to opt out to change.

Question 21

Mandated Choice

Answer 21

Economic agents are forced to make a choice, eg. opting in / out of organ donation.

Question 22

Restricted Choice

Answer 22

Economic agents are only given a few options to chose from, in order to direct them towards the greatest utility.

Question 23

Framing

Answer 23

Occurs when the way that a question or information is presented will influence consumer choice.

Utilises soft paternalism to effectively influence consumer behaviour to bring the market closer to the socially optimal level.

Question 24

Nudges

Answer 24

Nudging is a way of affecting people’s decisions while not forbidding other options or changing economic incentives.

It is easy to avoid or act differently with little costs attached.

Nudging is just making the option slightly easier/convenient to do.

It is an easy and low cost way of changing someone’s behaviour without reducing their number of choices.

Question 25

Charity - traditional view vs behavioural view

Answer 25

Traditional - People act charitably in order to make themselves feel good.

Behavioural - Charitability does not come purely from self-interest, but also the ideas of fairness and altruism.