LUBS 3375 - Behavioural Economics: Week 1 - Introduction

Question 1

What people do in any situation depends on 3 factors:

Answer 1

1. Preferences
2. Beliefs
3. Constraints

Question 2

Preferences

Answer 2

A ranking of all the possible outcomes that might result from their actions

Question 3

Beliefs

Answer 3

Beliefs about how their actions might bring about outcomes

Question 4

Constraints

Answer 4

The constraints limiting the actions they can take, e.g. wealth

Question 5

Preferences (further)

Answer 5

Preferences are reasons why people do things e.g. tastes, social norms, emotions

Question 6

Beliefs (further)

Answer 6

Beliefs are a persons understanding of the relationship between their actions and possible outcomes (probability of a certain action leading to a certain outcome)

Question 7

The preferences, beliefs and constraints (P-B-C) model

Question 8

What does it mean to be rational?

Answer 8

Popular meaning: To act rationally is to use reason (i.e. not emotional factors, instincts)

Economics meaning: Individuals have preferences over a set of available actions and act such as to achieve their most preferred outcome

Question 9

Preferences should satisfy two properties (axioms). These are…

Answer 9

Transitivity and Completeness

Question 10

Transitivity

Answer 10

Transitivity says “Option A is as least as good as option B, and option B is as least as good as option C, then option A is as least as good as option C.”

Question 11

Completeness

Answer 11

Completeness says “Option A is as least as good as option B, or option B is as good as option A, or both.” Completeness is about being able to rank all the potential options.

Question 12

The Utility Function

Answer 12

The utility function is a numerical representation of preferences.

If an individual’s preferences satisfy the properties of transitivity and completeness, then we can use the utility function to provide a mathematical representation of those preferences.