Individual Economic Decision Making Flashcards
Consumers aim to maximise their…
Utility
Producers aim to maximise their…
Profits
Total Utility
The satisfaction gained from consumption
Marginal Utility
The extra satisfaction derived from consuming one extra unit of the
good
Diminishing Marginal Utility
States that as additional products are consumed, the utility gained from the next unit is lower than the utility gained from the previous unit. Therefore, consumers are willing to pay less for extra
units.
Utility 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
Government policies that create economics incentives
Taxation, Subsidisation and Regulation
Thinking about the margin means…
Thinking about the effect of an additional action.
The importance of the margin when making choices
It allows consumers to keep thinking
ahead. It prevents consumers thinking about things they have already done, and
allows them to consider how to maximise their utility now or in the future.
When making choices, margins can also increase productivity, since the most
important tasks which maximise utility the most, are the ones which are prioritised.
Imperfect Information
Where information is missing, so an informed relation cannot be made.
Imperfect information leads to…
A misallocation of resources, consumers might pay too much or too little and firms produce an incorrect amount- could lead to exploitation
Asymmetric Information
Unequal knowledge between producers and consumers
Asymmetric information leads to…
Misallocation of resources (Market Failure)
Principle-Agent Problem
Interests of a company’s owners (the principals) are not aligned with those of its managers (the agents) who make decisions on their behalf
Ways to reduce the Principle-Agent Problems
- Align incentives (Offer incentives that are tied to the company’s performance)
- Increase transparency (Providing regular reports)
- Appoint independent directors (Act as a check on the decisions made by managers)
Bounded Rationality
Argues that people make decisions without gathering all the necessary information
Bounded Self Control
Suggests that individuals have a limited capacity to regulate their behaviour and make decisions in the face of conflicting desires or impulses
Types of Bias Decision Making
- Rule of Thumb
- Anchoring
- Availability
- Social Norms
Who Created the Bounded Rationality Model (Administrative Man Theory)
Herbert Simon
Assumptions of the Bounded Rationality Model
- The first alternative that is satisfactory is selected
- The decision maker recognises that they perceive the world as simple
- The decision maker recognises the need to be comfortable making decisions
without considering every alternative - Decisions could be made by heuristics.
Rule of Thumb (Heuristics)
This is when individuals make choices based on their default choice based on experience
Anchoring
Make decisions based on the first or a particular piece of information that they use as the ‘anchor’
Availability
Trying to make decisions based on the probability of an event happening e.g. the level of insurance to take out
Social Norms
Individual economics actors are strongly influenced in their decision making by the prevailing ‘social norm’ of the group/ society that they live in
Homo Economicus
Traditional economics theory assumes that every economic actor makes completely rational decision based on perfect information that act to maximise their own individual welfare
Daniel Kahneman - System 1
‘Thinking Fast’
Based on intuition which allows people to make shortcuts and makes decisions quickly- often affected by cognitive bias
Daniel Kahnemen - System 2
‘Thinking Slow’
Where individuals consider all the information available and aim to make rational decision
Loss Aversion
Avoiding losses to achieve equivalent gains
What does loss aversion illistrate
Individuals will avoid situations where potential losses are involved and take less risks where a potential loss may arise
At the same time they will be prepared to take a greater risk when a loss has occurred
Altruism
a concern for the welfare of others
Fairness
a normative judgement of what is right/reasonable
The importance of altruism and perceptions of fairness
Altruism, can have a big influence on how we make decisions. Even if it has a negative impact on them personally, people can make decisions that are good for society or for other people.
Decision-making can be influenced and negatively affected by unfairness or injustice. Distributive justice and procedural fairness are two ideas that have an impact on people’s willingness to collaborate, exhibit reciprocal behaviour, and make choices that are consistent with their sense of fairness.
Choice Architecture
The way choices are presented to consumers
Examples of Choice Architectures
Default choice- a choice is automatically chosen unless the individual chooses otherwise.
Restricted choice- too many options means individuals are less likely to participate in the activity, restricting choice means they’re more likely to participate.
Mandated choice- Legally enforced choice
Framing
How to information is presented
Nudges
Interventions that subtly encourage people to make particular decisions without limiting their freedom of choice.
