Individual Economic decision making Flashcards
What is traditional behaviour?
assumes households/ consumers always act rationally
What is rational behaviour?
people try to make decisions in their self interest or to maximise their private benefit
What does a change in the price of any good and a change in the non- price factors alter?
the economic incentives facing a consumer
What is utility?
defined as the pleasure or satisfaction obtained from consumption
What is total utility?
total satisfaction from a given level of consumption
What is marginal utility?
to the change in satisfaction from consuming one extra unit
What is the hypothesis of diminishing marginal utility?
as a person increases consumption of a good, there is a decline in the marginal utility derived from consuming each additional unit
What is marginal utility curve showing?
relationship between quantity and marginal utility
What does a fall in marginal utility mean?
that a consumer is getting less extra satisfaction from each subsequent unit consumed
What relationship does a conventional demand curve for a normal good have with price charged and quantity demanded?q
inverse relationship
What is the marginal consumer surplus?
the excess of a persons total utility from the consumption of a good over the price paid
MCS formula?
MCS = MU / P
What is consumer surplus?
the excess of what a consumer would have been prepared to pay compared to what they actually pay
What does orthodox economic theory suggest?
economic agents decide their market plans to maximise a target objective or goal which is consistent with the pursuit of self interest
What does demand theory suggest about utility maximisation?
households are assumed to maximise the utility from the consumption of goods and services
How does a consumer maximise utility?
obtaining all the goods which yield utility up to the point of satisfaction
WHen does satisfaction occur?
when no more utility can be gained from consuming extra units of a good
What constraints do consumers face due to scarcity?
- limited income (cant purchase all the goods and sevices they could possibly yeild)
- a given set of prices ( consumers cant influence market prices)
- budget constraints
How do you maximise utility when consuming one product?
- marginal utility should be equal to price when total utility is maximised
- marginal private benefit equals marginal private costs occured
- MU = P
How do you maximise utility across different products?
- consumer equalises the marginal utility per pound spent
- Value for money : marginal utility / price
What is perfect information?
consumers possess perfect information about the goods that are availbale to buy
What is imperfect information?
when people have inaccurate, incomplete, uncertain or misunderstood data
WHat are some causes of imperfect information?
- asymmetric information: buyer or seller has info the other doesnt
- misunderstanding the true costs and benefits
- complexity
- lack of information
- addiction
Give examples of information failure?
- risk from tanning bed
- addiction to drugs
- knowledge of nutritional content
- uncertain quality of seconf hand products
Give examples of asymetric information?
- landlords who know more then tennants
- mortgages
- car insurance companies
- doctors with drugs and medicine
- insider info on financial markets
What is a moral hazard?
- occurs when the party with superior information alters behaviour to benefit themselves while imposing cost on those with inferior information
Example of moral hazard?
- insured consumer likely to take more risks knowing their claim will be paid
What is behavioural economics?
method of economic analysis that applies psychological insights into human behaviour to explain individuals choices and decisions
What is traditional economics?
- creates theory and uses it to explain actual behaviour
what are the characterisistics of the standard economic theory?
- everyone is consistantly rational
- self- interested
- utility maximisers
- takes optimal route to achieve goals
What are the characteristics of behavioural economics>
- subject to biases
- subject to irrationalities
- use heuristics (short cuts) to make decisons
- inconsistent
- emotional
What does altruistic mean/
selfless
What three constraints to people face when making deciisons?
- imperfect info
- limited mental processing
- time constraint
What is bounded rationality?
when making decisions an individuals rationality is limited by the information they have, limit of their mind and their finite amount of time
What is bounded self control/
limited self control where individuals lack the self-control to act with self interest
What two ways dp humans think?
- system 1 (thinking fast)
- system 2 (thinking slow)
Explain system 1?
- intuitive and instinctive
- decisions made quickly, without analysis
- uses heuristics
- less subject to biases and errors
Explain system 2?
- reflective thinking
- concentration and mental effort required to work through problem
- bigger more important decisions
What is heuristics?
mental shortcut that allows people to solve problems and make judgments quickly and efficiently
What are the types of heuristic?
- availability heuristic
- representativeness heuristic
- affect heuristic
Explain availability heuristic?
- making decisions based on how easy it is to bring somehting to mind
Explain representativeness heuristic?
making a decision by comparing the present situation to the most representative mental prototype.
- comparing to examples you may hold
What is the effect heuristic?
making choices that are influenced by emotions you are currently experiencing
What is cognitive bias?
a mental error which occurs as a result of using rules of thumb or holding onto ones preferances or beliefs
What is the rule of thumb?
rough and practical method that can be easily applied when making decisions
What is the purpose of rule of thumb?
to encourage us to consider factors we otherwise would not
What is a downside of the rule of thumb?
doesnt take into account differances in individual circumstances
What is anchoring?
a cognitive bias describing when making decisions to rely too heaving on the first piece of information offered
What is availability bias?
when individuals place too mach weight on the probability of an event happening because they can recall vivid examples of similar events
What are social norms>
patterns of behaviour considered acceptable by society or group within that society
What is altruism ?
when we act to promote someone elses wellbeing, even though we may suffer as a consequence
What is the fairness motive?
some individuals have an aversion to inequality and are concerned about the wider distribution of income in a group or society
What is the reciprocity motive?
view suggests that individuals are often likely to take others into account in the expectation that their consideration will be reciprocated
What is the altruism motive?
view suggests that individuals may put others first and before themselves so that their actions benefit others more than themselves
What are some criticisms of behavioural economics?
- peoples observed behaviour in the labatory is not realistic
- self selecting nature of volunteers
- many experiments are rough and ready
Many exp