Economics Part 2

Question 1

What is individual economic decision making influenced by

Answer 1

Rationality
Incentives
Marginal utility

Question 2

Rational

Answer 2

Economic agents being able to consider the outcome of their choices and recognise the net benefits of each one

Question 3

How are workers assumed to act rationally

Answer 3

By balancing welfare at work with consideration of both pay and benefits

Question 4

How is the assumption of rational decision making flawed?

Answer 4

Consumers are often more influenced by emotional purchasing decisions than a rational computation of net benefits

Question 5

Marginal utility

Answer 5

The additional utility(satisfaction) gained from the consumption of an additional product

Question 6

How to calculate total utility

Answer 6

The marginal utility of each unit consumed is added together. This means total utility keeps increasing even while marginal utility is decreasing

Question 7

Law of Diminishing Marginal Utility

Answer 7

States as additional products are consumed, the utility gained from the next unit is lower than the utility gained from the previous unit

Question 8

Why does the Law of Diminishing Marginal Utility explain why the demand curve is downward sloping

Answer 8

1. When the first unit is purchased, the utility is high and consumers are willing to pay a high price.
2. When subsequent units are purchased, each one offers less utility and the willingness of the consumer to pay the initial price decreases.
3. Lowering the price makes it a more attractive proposition for the consumer to keep consuming additional units.
4. This is one reason why firms offer discounts such as 50% off the second item.

Question 9

How do rational consumers decide at the margin?

Answer 9

They weigh whether to consume a little more or a little less of something:
1. This involves considering the additional happiness or utility gained from each extra unit(marginal benefit) and the extra money spent(marginal cost)
2. Consumers continue to consume until the extra happiness from each unit equals the extra cost, which is making decisions at the margin.

Question 10

Asymmetric information

Answer 10

When buyers and sellers have different levels of information in many markets e.g. there’s asymmetric information in the used car market: sellers know more about the vehicle than the buyers

Question 11

How does asymmetric information result in over or under-provision of goods and services

Answer 11

Asymmetric information distorts socially optimal prices and quantities in markets, resulting in over or under-provision of goods or services:
e.g. goods/services with dangerous side effects would be sold in lower quantities if buyers were aware of these effects. Fewer factors of production should be allocated towards these

Question 12

Why does market failure occur?

Answer 12

Due to information gaps existing in nearly all free markets that distort market outcomes

Question 13

One assumption of free markets

Answer 13

There’s a perfect flow of information

Question 14

Traditional economics

Answer 14

Assumes consumers are rational, and driven by the utility they get from consumption.
Consumers make long term plans and follow them.
Consumers take as much time as they need to absorb all of the information in the market.
Consumers focus on the facts in a very logical manner, knowing exactly what they want and why they want it.

Question 15

Behavioural economics

Answer 15

Assumes humans are complex:
Information overload can complicate decision making
Consumers take risks, sometimes going against reason
Emotions play a large role in the decision-making process
The ability to make the best decision is influenced by many biases
People care about more than just maximising their self interest

Question 16

Behavioural economics

Answer 16

A field of study combining elements of psychology and economics to understand how people make decisions and behave in economic contexts, challenges the view economic agents behave rationally

Question 17

Bounded Rationality Theory

Answer 17

Argues people make decisions without gathering all the necessary information to make a rational decision within a given time period, the theory assumes rational decision-making is limited. Our decisions take into account time, choice of goods(wide range of goods and services in a free market economy) and information

Question 18

Limitations - individuals are unlikely to always make rational decisions

Answer 18

Bounded rationality
Bounded self-control
Cognitive biases - we base our decisions upon them

Question 19

How do businesses take advantage of the lack of bounded self-control

Answer 19

Businesses use marketing to capitalise on the lack of bounded self-control of individuals when appealing to their target audience to maximise sales e.g. supermarkets place a range of items at the checkout register to encourage impulse purchases

Question 20

Influence of biases on decision making

Answer 20

Biases influence how we process information when making decisions and these influence the process of rational decision-making

Question 21

Types of cognitive bias

Answer 21

Rule of Thumb
Anchoring and framing
Availability bias
Social norms
Loss aversion: Endowment effect
Herd behaviour
Choice architecture

Question 22

Rule of Thumb

Answer 22

When individuals make choices based on their default choice based on experience e.g. individuals may also order the same pizza anytime they order from Pizza Hut.

Question 23

Anchoring bias

Answer 23

When individuals rely too heavily on an initial piece of information when making subsequent judgements or decisions

Question 24

Example of anchor bias

Answer 24

When buying a used car, the seller may initially suggest a price of $10,000. Even if you know the market value is lower, the anchor of $10,000 might still influence your perception and as a result, the consumer ends up paying a higher price than intended

Question 25

Framing

Answer 25

How the presentation/words of information can significantly influence people’s choices or judgements e.g. consumers are more likely to purchase a product stating 80% fat free than 20% fat.

Question 26

Availability bias

Answer 26

When people rely on immediate examples/information coming to mind easily when making judgements or decisions e.g. people use alternative modes of transport when there’s a plane crash, even though the probability of a crash happening is very low. We make decisions depending how easy it is to conjure examples, despite the probability of an event not being too high e.g.if we expect business rates to go up, consumers spend less money.

Question 27

Traditional economics assumption

Answer 27

People always act in their own self interest

Question 28

Altruism

Answer 28

The idea behaviour benefits a group, at the expense of the person performing it

Question 29

Major drivers in non-rational decision making process

Answer 29

Altruism
Perception of fairness - what individuals and societies deem to be right or wrong

Question 30

Choice architecture

Answer 30

Choice architecture refers to the intentional design of how choices are presented to influence decision making

Question 31

Example of choice architecture

Answer 31

Supermarkets place more profitable products at eye level on the shelves

Question 32

Choice architecture e.g. how it aims to simplify the decision making process

Answer 32

Restaurants present information about food options in a particular format to encourage individuals to make a particular choice

Question 33

Types of choice architecture

Answer 33

Default choice
Restricted choice
Mandated choices

Question 34

Default choice

Answer 34

Occurs when an individual is automatically signed up to a particular choice/decision

Question 35

Examples of default choices

Answer 35

When signing up for an online service, the default choice for receiving promotional emails may be set to “opt-in”

Question 36

Mandated choices

Answer 36

Mandated choices require individuals to make a specific decision or take a particular action by imposing a requirement or obligation

Question 37

Examples of mandated choices

Answer 37

Some countries mandate car insurance, which require all vehicle owners to make an active decision to choose and purchase car insurance, rather than leaving it as an optional choice

Question 38

Advantages of choice architecture

Answer 38

Influences behaviour
Simplifies decision-making
Improved outcomes e.g. effective choice architecture can encourage healthier eating habits
Enhances decision quality e.g. can provide guidance, reduce biases and increase the likelihood of individuals making choices they would consider to be better

Question 39

Disadvantages of choice architecture

Answer 39

Manipulation - influences people’s decisions without their explicit consent
Ethical concerns - the way choices are presented means individuals may not be aware their choices are being influenced or of the consequences of their decisions
Potential for bias - inherent in the design process, may be used by companies to increase profits
Unintended consequences - Changes in the presentation of choices can have unforeseen effects and the outcomes may not align with the original goals.

Question 40

Heuristics

Answer 40

Using the rule of thumb in decision making(debating and collecting information) rather than rationality - where we base most of our decisions on common sense/our lives experience. Consumers follow heuristics to make satisfying/satisficing decisions(even when utility/maximisation may be sacrificed)

Question 41

Endowment effect

Answer 41

Attaching too much monetary value to something you have