Individual Economic Decision Making

Question 1

Rational economic decision making

Answer 1

Rational behaviour - decision making process that’s based on people making choices that result in maximum level of utility for an individual

Question 2

Economic incentives

Answer 2

Economic agents respond to incentives which can allocate scarce resources to provide the highest utility to each agent
Rewards are positive incentives which I’ll make consumers better off
When incentives are not given properly, resources will be misallocated
Prices in market economies provide signals to buyers and sellers which is an incentive to purchase or sell good which changes their behaviour

Question 3

Utility theory

Answer 3

When making econ decisions consumers aim to maximise utility and firms aim to maximise profits
Consumers utility - total satisfaction received from consuming a good or service
Marginal utility - extra satisfaction derived from consuming one extra unit of the good

Question 4

Law of diminishing marginal utility

Answer 4

Demand curve is downward sloping due to law of diminishing marginal utility

• states that consumer surplus generally declines with extra units consumed as extra unit generates less marginal utility than the one already consumed
  Therefore consumers are willing to pay less for extra units

Question 5

Utility maximisation

Answer 5

Is when consumers aim to generate the greatest utility possible
Firms aim to generate the greatest profits
- assumed economic agents act in own interests

Question 6

Incentives

Answer 6

Entrepreneur wants to avoid loss and gain profit which makes them want to innovate so can reduce production costs and improve quality of thei products
Firms need an incentive to engage in risk taking so innovate. Without innovation production costs will be more and there will be a misallocation of resources.

Question 7

Limitations

Answer 7

Not the best or realistic way for firms to make decisions
Takes longer time to decide which is not practical in a firm with strict time constraints

Question 8

Importance of the margin when making decisions

Answer 8

Allows consumer to think ahead and prevent consumers from thinking about things they have already done and allows to consider how to maximise utility

Margins can increase productivity since more important tasks which maximise utility the most are ones which are prioritised

Question 9

Symmetric information

Answer 9

Consumers and producers have perfect information and equal information in a market
Leads to efficient allocation of resources

Question 10

Imperfect information

Answer 10

Where information is missing so an informed decision cannot be made
This makes it difficult for economic agents to make rational decisions which maximise their utility and is a potential source of market failure
Leads to a misallocation of resources where consumers may too much or too little and firms might produce incorrect amount
E.g monopolies

Question 11

Market failure

Answer 11

When markets fail to supply in quantity
When wrong quantity of a product produced or supplied at a wrong price
This may lead to over consumption or under consumption
Or oversupply or undersupply

Question 12

Asymmetrical information

Answer 12

Leads to market failure. This is when there is unequal knowledge between consumers and producers.
One economic agent knows more than another, giving the, more power in a market

Can lead to misallocation of resources.

Information could be made more widely available through advertising or gov intervention e.g harmful effects of smoking made public through messages on cigarette box

Question 13

Examples of asymmetric information

Answer 13

Second hand markets ( buying a car )
Buyer might not have enough information on a certain car and seller may have all information on the car
Buyers make irrational decision and choose to purchase car

Insurance markets ( car insurance )
- only driver knows how well or how dangerous they drive
Person trying to sell their insurance may issue a wrong price for service.

Question 14

Behavioural economics

Answer 14

States that a consumer will not always be rational, and therefore they may not always look to maximise utility
Disputes rationality and utility maximisation, arguing that emotional, social and psychological factors can influence decision-making
Question that assumption of traditional economic theory that individuals or rational decision makers who want to maximise their utility.

Question 15

Bounded rationality

Answer 15

The decision-making capacity of humans cannot be fully rational because of a number of limits we face.

Question 16

Limits of bounded rationality

Answer 16

Information failure - may not be enough info or may be unreliable
Time - amount of time we have to make decisions
The limits of the human brain to process every piece of mod
Impacts of emotions on decision making

Question 17

Bounded self control

Answer 17

Making irrational decisions, even when the consumer is aware of the consequences
Making decisions which provide short term utility at expense of long term utility
E.g gambling, binge drinking. All inclusive holiday

Question 18

Things that stop economic agents ability to make rational decisions

Answer 18

Bounded self control
Bounded rationality

Question 19

Biases in decision making

Answer 19

Anchoring
Social norms
Rule of thumb
Framing
Altruism

Question 20

Anchoring

Answer 20

When individuals rely too heavily on the first piece or information offered when making a choice between different goods and services
E.g RRP and shops price. We compare the two prices

First piece of info causes consumers to be biased towards it when subsequent info given

Question 21

Social norms

Answer 21

Decisions influenced by rules which society has dictate. Social pressure encourages consumers to do things they would not do otherwise.
Social norms forms patterns of behaviour considered acceptable by a society
E.g tipping

Question 22

Availability

Answer 22

Form of bias where people make judgements about probability of events by recalling recent, personal or memorable instances
E.g consumers likely to think plane accidents more likely to occur even if they are very rare. And overestimate probability
Spread accord populations by reporting them in news and media

Question 23

Altruism and fairness

Answer 23

Altruism - act of being selfless and considerate towards others
- individuals are motivated to the right thing even if it means paying more

Individual consumers can gain a sense of genuine satisfaction, and extra utility from acting in these ways.
However, critiques of altruism, and fairness argue that people simply fear being judged, especially in the world where information flows freely through social media.

Question 24

Choice architecture

Answer 24

Refers to the way choices are presented to consumers.
Different designs affect choice consumers make
Well designed choice architectures help consumers avoid making irrational decisions and poor choices which can improve welfare

E.g organ donations
Countries with opt out have higher rates than counties with opt m

Question 25

Framing

Answer 25

The way consumers are influenced by the way information is presented to them
E.g colours, text ,size of text, low sugar
Advertising cost of gym at 25 a month rather than 1300 a year

Question 26

Nudges

Answer 26

Technique used to influence consumer behaviour via use of gentle suggestions and positive reinforcements and aims to change behaviour of consumers without taking away freedom of choice.
E.g 5 a day campaign. Rather than banning. Replacing with healthier foods
Allows consumers to make a free choice - but alters behaviour to choose healthier option

Sometimes argued that they are manipulative and consumers do not get a free choice with them
Due to imperfect information that exists between consumers and firms nudges can prevent consumers making poor choices so welfare is maximised

Question 27

Default choices

Answer 27

Setting the socially desirable option as the default option
Consumer is automatically enrolled into a system
E.g organ donation e.g pension schem
It is the choice consumer takes if they take no action

Question 28

Restricted choice

Answer 28

Offering people a limited number of options when making a choice eG school lunches
Choice of consumer is restricted

Question 29

Mandated choice

Answer 29

Where people are required legally to make a choice.
When consumers are required to state whether they way to participate in an action .