Micro 13 - Behavioural Economics and Causes of Market Failure Flashcards
Classical economists belief
> In classical economics it is assumed that economic agents are selfishly motivated by utility.
It is assumed they are fully informed about the eventualities of all their decision, both in the short and long term.
This rational, measured economic agent is referred to as ‘homo-economicus’.
Most classical theory is built around the assumption that this how all economic agents behave.
In reality, human beings aren’t like this at all.
Homo Economicus - definition
> Homo Economicus is a hypothetical concept that humans are:
- Self-interested
- Know what they want
- Make rational decisions to maximise their utility.
- These choices are based on the concept of marginal utility.
Why doesn’t the homo economicus assumption work?
- Lack of information.
- Asymmetric information.
- Habit-forming.
- Most people want to ‘do the right thing’.
Bounded Rationality - definition
> Bounded rationality is the limits on decision making.
The idea that people tend to satisfice (make a satisfactory decision) rather than spend ages trying to make a rational decision which maximises utility.
Why does bounded rationality occur?
- Time available to make decisions is limited.
- Not all information is available, or incorrect.
- Computation weakness (the idea that people might not be able to process and evaluate the vast amounts of data involved in making a decision, and they might not be very good at calculating the costs of alternatives.
Bounded Self-Control definition
> Individuals have limits on their self-control.
Biases that stop individuals acting in an economically rational way - list
- Rules of thumb
- Anchoring
- Availability bias
- Social norms
- Habitual behaviour
Biases that stop individuals acting in an economically rational way - rules of thumb
> Simple, useful tools that help an individual make a decision.
Biases that stop individuals acting in an economically rational way - anchoring
> This means placing too much emphasis on one piece of information.
E.g. people may take their first quote as their judgement of a ‘fair’ price.
Biases that stop individuals acting in an economically rational way - availability bias
> This is where judgements are made about the probability of events occurring based on how easy it is to remember such events occurring.
Biases that stop individuals acting in an economically rational way - social norms
> An individual’s behaviour can be influenced by the behaviour of their social group.
Biases that stop individuals acting in an economically rational way - habitual behaviour
> Doing the same thing over and over again.
What else affects decisions
> Fairness and altruism affect decisions.
Behavioural economists recognise that individuals don’t just act out of self-interest.
Government polices
Choice architecture - definition
> Where an individual’s choice is influenced by adapting the way the choice is presented.
Governments can use behavioural economic theory for policies.
Choice architecture - methods
- Default options
- Framing
- Nudges
- Restricted choice
- Mandated choices
