Individual economonic decision making Flashcards
What is the difference between utility and marginal utility?
Utility is the satisfaction or economic welfare an individual gains from consuming a good or service. Whereas marginal utility is the additional welfare, satisfaction or pleasure gained from consuming one extra unity of a good or service.
What is diminishing marginal utility?
For a single consumer, the marginal utility derived from a good or service diminishes for each additional unit consumed
Eg- a glass of water on a hot day. The first glass has a very high marginal utility but as you keep drinking, you begin to get full up and so the water is not longer as refreshing and so the marginal utility you gain falls.
What is utility maximising?
Utility maximisation refers to the concept that individuals and firms seek to get the highest satisfaction from their economic decisions.
What are the 4 constraints of utility maximisation?
Limited Income- consumers do not posses unlimited income. Income spent on one good cannot be spent on other goods and services - the opportunity cost of production. they must choose which goods to purchase.
Given set of prices- Consumers cannot influence price by their own actions. given this assumption consumers are ‘price-takers’.
Budget Constraint- limited income and given prices force a budget on consumers freedom of action in the market.
Limited Time- Even if goods are free it is often impossible to consume more than one good at a time
What is asymmetric information?
When one party to a market transaction possess less information relevant to the exchange than the other
Examples of asymmetric information
- Employment- when employing a worker, a firm doesn’t know how hard the worker will work. The employer can look at his CV and past references, but once employed he cannot guarantee the attitude of the worker.
- Used car sales- When looking at a car, a buyer can only see the externals and cannot know how reliable the engine is. The seller is aware of the total value and may withhold this information to charge a higher price
- Insurance- When insuring a good, the insurer is uncertain how well the customer will look after a piece of property. the customer may lie about their health or value of an item in order to get a cheaper quote.
How can asymmetric information be avoided?
Employ a mechanic to test the car and find the real value. Give out a warranty to ensure the reliability of the car.
Insurance policies to use a no-claim bonuses to encourage people to take better care of the item in order to gain these benefits.
The internet- search up information, look at reviews. reviews provide an incentive to only sell good that are corrected marketed
What is adverse selection and what can lead to it?
Adverse selection occurs when there is asymmetric information between buyers and sellers. This unequal information distorts the market and leads to market failure.
For example, buyers of insurance may have better information than sellers. Those who want to buy insurance are those most likely to make a claim. Therefore firms are reluctant to sell insurance.
Adverse selection occurs because of information asymmetries and the difficulties in selecting customers.
What book did George Akerlof write in 2001 and what was it about?
He wrote a book called ‘the market for lemons’. It was about the second-hard car market. He wrote how asymmetric information has developed. sellers have more knowledge about the quality of the car than the buyers. good and bad cars must then sell at the same price as buyers cannot tell the differences between a good and bad car. Bad cars will be traded and good cars will not be traded. the bad cars then tend to drive out the good.
Define behaviour economics
A method of economic analysis that applies psychological insights into human behaviour to explain how individuals make choices and decisions
What is bounded rationality?
Traditional economists assume when exercising a choice, individuals are perfectly rational, they make decisions in the context being fully informed, with perfect logic and aiming to achieve the maximum possible economic gain. HOWEVER, when making a decision, individuals rationality is limited by the information they have, the limitations of their minds, and the finite amount of time available in which to make decisions.
Why does bounded rationality end up satisficing rather than maximising choices?
Individuals, no matter how high or low their intelligence is, make decisions based of three constraints
1. Imperfect information about possible alternatives and their consequences
2. Limited mental processing ability
3. A time constraint which limits the time available for making the decisions
So in complex choice situations, bounded rationality often results in satisificng rather than maximising choices
What is the difference between traditional economists and behaviour economics view on self control?
(bounded self-control)
Traditional economic theory implicitly assumes that when making choices, individuals have complete self-control.
Behavioural economists believe that individuals have bounded self-control. this is limited self-control in which individuals lack the self-control to act in what they see as their best interests.
eg- smoking, they know it is against their best interests to smoke but do not have the self-control to stop.
Explain an
- automatic system
- reflective system
An Automatic system involves everyday economic decisions such as buying a coffee at the train station. it is often quick, intuitive decisions.
A Reflective system involves bigger and more important decision such as buying a house. decisions that require thinking and an important choice.
What do behavioural economists claim the role of bias is in automatic thinking?
They argue that quick decisions that people make automatically are often heavily biased because the decision is made off of their likes, dislikes and past experiences.
