Individual Economic Decision Making Flashcards
Diminishing marginal utility
The law of diminishing marginal utility suggests that consumer surplus generally declines with extra units consumed. This is because the extra unit generates less utility than the one already consumed. Therefore, consumers are willing to pay less for extra units.
Maximisation
Maximisation for consumers is when consumers aim to generate the greatest utility possible from an economic decision. Firms aim to generate the highest profits possible.
The Rational Decision Making Model
1) Identify the problem: For a firm, this might be falling profits.
2) Find and identify the decision criteria: The firm might have to find information
or criteria that will increase their profits. The firm’s criteria might include, for example, keep a certain number of employees or to not change the price of their goods. The criteria might include how the decision will affect stakeholders (the customer and the staff, for instance), and how the quality might be affected.
3) Weigh the criteria: The firm will have to rank the criteria based on their relative importance. They might think keeping all of their employees is the most important, for example.
4) Generate alternatives: The firm might consider some alternative options. For instance, they might think that moving their premises somewhere else will reduce costs and hence increase profits. Perhaps they will consider a loyalty scheme or a promotion for the consumer. Alternatively, the might decide to reduce the size of their workforce.
5) Evaluate alternative options: The firm might now consider which of the alternatives meet their criteria the best, and help them increase their profits the most.
6) Choose the best alternative: Now the firm will choose the alternative they think meets their criteria.
7) Carry out the decision: The firm can now see what the consequences of the decision are.
8) Evaluate the decision: After seeing what effect the decision has on the firm, they can consider whether this was the best option or not.
Limitations of Rational Decision Making Model
This is not always the best or most realistic way for firms to make decisions. Although it might be fairer than making an intuitive decision, it takes significantly longer to decide, which is not practical in a firm with strict time constraints.
Symmetric information
Means that consumers and producers have perfect market information to make their decision. This leads to an efficient allocation of resources.
Imperfect information
Where information is missing, so an informed decision cannot be made.
This leads to a misallocation of resources.
Consumers might pay too much or too little, and firms might produce the incorrect amount. For example, monopolies might exploit the consumer by charging them more than they need to.
Asymmetric information
Asymmetric information leads to market failure. This is when there is unequal knowledge between consumers and producers. For example, a car dealer might know about a fault with the car that the consumer is unaware of. This could lead to a misallocation of resources. Consumers can also know more information than the producer, such as when purchasing insurance policies.
