Individual Economic Decision Making

Question 1

Rational behaviour

Answer 1

People try to make decisions in their self-interest or to maximise their private benefit. For a household, this would mean attempting to maximise the welfare, satisfaction or utility gained from the goods or services consumed

Question 2

Utility

Answer 2

The satisfaction or welfare obtained from consumption

Question 3

Marginal utility

Answer 3

The additional satisfaction or pleasure from consuming on extra unit of the good/service

Question 4

Diminishing marginal utility

Answer 4

As a person increases consumption of a good- while keeping consumption of other products constant- there is a decline in the marginal utility derived from consuming each additional unit of the good

Question 5

Utility-maximising consumer

Answer 5

Consumers attempt the maximise the welfare or utility they gain from the good and services they decided to consume. They do this by comparing the costs and benefits of alternatives. A utility-maximising consumer must choose to consume or demand a good up to a point at which marginal utility = price

Question 6

How does scarcity restrict consumer choices

Answer 6

Limited income, a given set of prices that consumers cannot actively influence, limited time available to consume multiple products- must choose one, the budget constraints

Question 7

Imperfect information

Answer 7

Traditional theories assume that individuals possessing perfect information will make decisions to maximise welfare or correctly choose between alternatives. However economic agents usually don’t have perfect information and make ‘wrong’ decisions and cause market failure

Question 8

Asymmetric information

Answer 8

When one party to a market transaction possesses less information relevant to the exchange than the other. One ways asymmetric info can manifest itself is through adverse selection- sellers have more knowledge than buyers. Can lead to making ‘wrong’ decisions even thought it was rational

Question 9

Behavioural economic THEORY

Answer 9

A method of economic analysis that applies psychological insights into human behaviour to explain how individuals make choices and decisions. Challenges assumptions in traditional economics that economical agents are utility maximisers and rational. Use their insights to design policies or interventions that can encourage, support and enable people to make better choices for themselves or society

Question 10

Bounded rationality

Answer 10

When individuals make decisions, their rationality is limited by three unavoidable constraints: imperfect info, limited mental processing ability,time constraint. In complex choice situations, bounded rationality often leads to satisficing rather than maximising choices

Question 11

Bounded self-control

Answer 11

A rational individual is assumed to have total self-control however behavioural economists believe individuals lack self-control to act in what they see as their self-interest even if they have prefect knowledge

Question 12

Thinking fast and thinking slow

Answer 12

Manly of our economic decisions are taken by our automatic system: decisions are made quickly, and little effort is used to analyse the situation. Bigger and more important decisions tend to be taken by our reflective system: relatively slow, involving careful and logical thought, can be tiring

Question 13

Bias in decision making

Answer 13

Argued that quick decisions that people make when choosing are often heavily biased. This is because decisions are made based on one’s own likes, dislikes and past experiences. ‘Rule of thumbs’ are used to help make sensible decisions based on limited info

Question 14

Cognitive bias

Answer 14

A mistake in reasoning or other thought process as a result of holding onto one’s preferences and beliefs regardless of contrary info

Question 15

Availability (Recency) bias

Answer 15

When individuals make judgements about the likelihood of future events according to how easy it is to recall examples of similar events. Often leads to decisions not based on logical reasoning. For example purchasing lottery tickets because you’ve seen winners living lavishly on tv

Question 16

Anchoring

Answer 16

The tendency when making decisions to rely too heavily on the first piece of info offered. Individuals use this initial piece of info when making subsequent judgments.

Question 17

Social norms

Answer 17

Patterns of behaviour considered acceptable by a society. By unconsciously learning and being influenced from the behaviour of others, social norms are established

Question 18

Altruism

Answer 18

When we act to promote someone else’s wellbeing even though we may suffer consequently and aren’t guaranteed to receive any benefit from it: it often results from people’s perceptions of fairness

Question 19

Loss aversion

Answer 19

The tendency to prefer avoiding losses to acquiring equivalent gains. Individuals don’t like to lose things that we own and tend to become extremely attached to goods in our possession and feel anxious to give them up even if the chance of losing the good is very low and chance of gain is much higher

Question 20

Choice architecture

Answer 20

Choice architecture is a framework setting out different ways in which choices can be presented to consumers, and the impact of the presentation on consumer decision making. This may be used to ‘nudge’ consumers to opt for choices that are deemed to be in their best interest, to achieve a socially desirable outcome.

Question 21

Default choice

Answer 21

An option that is selected automatically unless an alternative is specified. Countries that require people to opt out of a certain thing generally have a much high proportional of the population registered for that certain thing than countries that ask people to opt in, because individuals are more likely to choose the ‘default’ option

Question 22

Framing

Answer 22

How the context, in which the information is presented, influences the choices people make

Question 23

Mandated choices

Answer 23

When people are required to make a decision and not merely go ahead with default position. Most people may choose the recommended settings but still must make an active decision to do so

Question 24

Restricted choice

Answer 24

When there is a limited number of options offered so they are not overwhelmed by the complexity of the situation. With too many choices, people may make a poorly thought-out decision or not make one at all.

Question 25

Nudges

Answer 25

Factors that encourage people to think and act in particular ways. They attempt to shift group and individual behaviour in ways that comply with desirable social norms but still allow individuals to make a choice

Question 26

Negatives of decision making

Answer 26

Too paternalistic?
Very unpredictable and costly
Based on fallacies and biases that people are sensible and can make rational decisions on their own

Question 27

Habitual behaviour

Answer 27

A routine of behaviors of certain individuals. You drink coffee every morning at your local shop instead of having it at home. Although this might not be the most rational decision if you’re trying to save money, you will still make it because it’s a habit

Question 28

Herd behaviour

Answer 28

A phenomenon in which individuals act collectively as part of a group, often making decisions as a group that they would not make as an individual. They may not be rational

Question 29

Traditional economics

Answer 29

Make the assumption that people can gather all info and weigh up the positives and negatives, they argue that everyone is rational and that the rational consumer can take time to make a utility maximising decision. Assumes everyone to be infinitely rational

Question 30

Behavioural economics

Answer 30

Disputes rationality and utility maximisation, arguing bounded rationality by time, choice or info, and bounded self control as consumers follow heuristics like rule of thumbs to make satisficing decisions over utility decisions. Explains that emotional, social and psychological factors can influence decision making

Question 31

The 5 choice architectures

Answer 31

Framing, Nudges, Default choice, Restricted choice, Mandated choice

Question 32

Priming

Answer 32

Our behaviour by cues that work subconsciously and prime us to behave in certain ways —>playing certain types of music in a shopping mall