Individual Economic Decision Making Flashcards
Consumer behavior
What it the utility theory
When making economic decisions consumer aim to maximise their utility and firm aim to maximise their profit
Consumer utility is the total satisfaction received from consuming a g/s
- it is not directly measurable
Marginal utility = is the extra satisfaction derived from consuming extra unit of the good
The demand curve will be downward sloping due to the law of diminishing marginal utility
= as person conusmes more unit of g/s= the extra satisfaction or marginal utility gained from the wfh additional unit will decrease
This is because extra unity generates less utility than the one already consumed
Therefore consumers willing to pay less for the extra good , however may be willing to buy more what price decrease
Utility maximisation
Maximization occurs when economic agents aim to generate greatest utility possible from an economic decision
Firm wish to maximise profit, gov wish to maximise their welfare of the population
Workers wish to maximise welfare derive flat work
So economic agents tried to obtain the most they can get from the economic activity they undertake
Assumed that they only act in their own interest
Rational decision making and economic incentives
Economic events respond to incentive which can allocate scarce resources to provide the highest utility to each agent
For the entrepreneurs in a firm = the incentive for taking risk is profit. And high price in the market economies provide signal to buyer and seller = incentive to purchase or sell the good= this change their behavior
Lead to entrepreneur want to innovate to reduce their production cost and improve quality
.firm or and individual can make decision using intuition or act rationally.
Intuition uses the feeling and instincts of the consumer and does NOT use facts
Business uses this when they do not have access to facts or need making decision is difficult
Rations decision making is when people used all the info available
The importance of the margin when making choice
- thinking at a margin means thinking about the effect of an additional action
An action could involve a marginal increase in product or a marginal cost
Is important as it allows consumers to keep thinking ahead . Prevent them thinking about things they already done= allow them to consider how to maximise their utility now or in future
When making choice margins can also increase productivity since most important task which maximized utility are prioritized
How to work out average utility
Average utility divided by quantity
When is total utility maximized
Total utility is maximized when MU= 0 so consuming additional unit of product no longer provides any extra satisfaction
Imperfect information
- according to traditional economic thought , assume there full information when consumers look to maximise their utility where MU = 0
BuT in real world imperfect info can prevent consumer acting in rational utility maximizing way
The importance of info for decision making
- info is essential for making sound economic decisions.
Without info it’s impossible to properly evaluate cost and benefit or make informal choices
Symmetric info.0 consumers have perfect market info to make their decision.= efficient allocation of resource
HOWEVER
There could be imperfect info
where info is missing so an informed decision cannot be made
= leads to misallocation of resource
= consumers may pay too much or little and firms might produce the incorrect amount such as monopolies
Also information gaps can occur when people have inaccurate , incomplete data and so potentially make wrong choice in market
— under consumption of merit goods = there’s not enough info which tells consumers how good of consuming that f/s is such as healthcare, education,fruit and veg= result in irrational decision being made
Underconsumption = not utility maximizing
Demerit goods - not enough info on how bad consuming these are for individuals consumer
Overconsumption= irrational it we are going beyond utility maximisation
An example is addiction to drugs, uncertain quality of second hand products, impact on anti - vaccination
The significance of asymmetric information
Asymmetric info leads to market failure . This is where one party in a. Transaction has more or better info then the other so there unequal knowledge
Can lead to problems in decision making as party with less info can’t make best choice
Also lead to misallocation of resources
Consumer can know more info than the producers such as purchasing insurance policies , loans
- info can be more widely distributed through advertising or gov intervention such as harmful effects of smoking could be made to public through adverts or message in boxes
E.g
Labour market- potential worker has got all the info about how they are as workers such as their productivity, skills , work ethic , the employer does NOT have that info, can’t get the whole perfect ink
- as a result employer may make irrational decision to employ a worker , not necessarily maximizing their benefit
- also second hand market- George akerlof =. Talked about the issue of 2nd hand car market where it’s always the buyer lacking info where’s seller has all info about state of the car
- the buyer may make irrational decision to buy the car
- also insurance market- person that has the info is the car owner- know how much of a dangerous driver they are= but insurance company doesn’t have that info= difficult to issue a price on the insurance on the individual
- for individual it’s always an incentive to under report the level of risk / how dangerous of a driver they are to keep price of insurance low
- company make irrational decision= issue insurance at a price lower then what should be charged as not enough info is stored
= leads to moral hazards , individuals takes more risk as they are not going to bear cost of those risk, it will be the insurance company - shows that imperfect info can lead to irrational decision being made where utility not necessarily being maximise in each case
Aspect of the behaviour theory
Behavioral economics dispute the idea that consumer are always rational, always look to maximise their utility
- behavioral economics will argue that emotional , social and psychological factors can influence decision making
According to traditional economics, consumers are always rational , will always look to maximise utility when they make consumption decision
When they first make decisions, they gather all info, weigh up the cost and benefit and decide air time to consider and make a utility maximizing decision
What is bounded rationality
- is a concept that acknowledges that people decision making limited by cognitive bias , incomplete info, any other constraints
Influence by emotion. , social pressures
Behaviour economics believe this as :
Consumer don’t have the time to make a saris utility maximise decision
Many choices = hard to evaluate all the cost and benefit when buying as it can overwhelm consumer
- also may be lack of info / asymmetric info= all can get away of rationality
What is bounded by self control
- assumes that consumers are able to exercise their self control but consumer are unable to do it with some decision
- so consumer are bounded by self control which can get in the way of taking decisions which maximise utility
The law of diminishing marginal utility suggest that every extra unit consumed provide a smaller benefit to consumer yet such as food, some consumer will still eat more than give them optimal benefits
Another example is short term and long term view . In long run , consumer feel as though they could start saving tomorrow = this procrastination = consumers making irrational decisions by not having self control
Another example - sugary drinks- consumer knows the negative effects of too much sugary drinks such as rotted teeth diabetes,= went to cut down but their self control get in the way= maybe addiction to sugar
Other example are nicotine, cigs, gym
As a result behaviorist could say BR and BS, consumer will sometime follow heuristic ( mental shortcut)- a more appropriate way on bettering consumer decision making= if there’s BR and BS in play
However it lead to bias in decision making
What heuristic
- are mental shortcuts that many people use in their day to day lives to simplify complex decisions to come to a reasonable decision
Helps avoid taking too long to make decision and avoid the problem. Of having imperfect info
For example consumer might use common sense or intuition Like buy the cheapest option or the most popular one, or only by good if it’s in sale
- use of rule of thumb
=lead to irrational decision being made like cheap = low quality
But save time and cognitive effort
Don’t need to do complex analysis of cost, quality and other factor
Other bias in decision making
(Emotional , social , psychological factor)
Social norm
- is a rule or expectation of behaviour within a group or culture - guides people how they should behave ins certain situations
So behaviour of other people affects how consumer acts
This social pressure encourages consumer to do things they wouldn’t do
Consumer are unwilling to change, if it goes against the norms of society
E.g. wiring behaviour in shops = making seat belts compulsory
Anchoring
- this is a type of bias created by the human tendency to rely on the first piece of info given and base their decision on it
Even if it’s not the most relevant piece of info
Causes consumers to be biased towards it
Such as if car original price is high but is on a scale for a lower price more than cars value
- known as the bargain hunting - original price acts as a anchor than influence their perception of the sale price
- another example is negotiating a price of salary = people often anchor on the first number mentioned
Availability
A form of bias towards an event that was recent , personal or memorable = this is because they are overestimated and cause emotional responses
It’s the tendency to give more weight to info that’s easily accessible in our memory
- for example if consumer are likely to think plane accidents are much more likely to occur= if they have been involved in one or know someone else who has
- even though they are rare = they oversitomstr the probability = this then influence how consumer behaves
-this type of bias is spread across population by reporting them in need and media
- another example smoking - we already know someone elderly either has smoked and lived a long life= some people will then think smoking isn’t as risk but disregards evidence on the negative impacts of smoking
The importance of a altruism and perception of fairness
- such as charity,
Traditional economic thought find it difficult to make sense of why someone will oils give up huge money for charity however NOT ALL THE TIME, CONSUMERS ARE UTILITY MAXIMISER
Consumers have morals, feeling influence decision making
Altruism is the act of being selfless and considerate towards others people without expecting anything in return. Economic agents will help each other at their own expended and believe in fairness of society
Altruism can also influence pro social behaviour like acts that benefit society such as charity
-. Another example - traditional economic thought wouldn’t firm only employ worker when they are needed to boost profit as firms are profit maximiser
However economically firm have other consideration = don’t want employees living in streets, have a good standard of living
= that why they hire them even if there’s not need to hire them/ firms are concerned of level of unemployment in society = want to make a change
These biases economic agent decision making meaning it’s more difficult to make assumption about rationality
