Microeconomics: Individual economic decision making Flashcards
What is rational decision-making?
People use all the information available to them
People try to maximise total satisfaction
People make independent choices
Consumers have stable performance
What is rational choice theory?
We assume people maximise the satisfaction they get from spending a limited budget.
What challenged the rational choice theory?
The behavioural revolution by highlighting how people often make decisions that are not fully rational and are influenced by emotional, cognitive, and social factors.
What is utility?
The satisfaction/benefit that a person gets from consuming a good/service.
measured via “utils”
What is perfect information?
People are aware of all the options and the consequences of those options and make decisions accordingly.
What is imperfect information?
People may not be aware of all the alternatives available leading to suboptimal decisions.
What is homo economics?
Calculating every cost and benefit
Can compute probabilities
Feel no emotion/regret
What is irrational behaviour?
People make systematic and persistent deviations from rational choice. e.g. emotional decision-making
What is herd mentality?
People follow the crowd without thinking critically about their own preferences. e.g. buying the latest iPhone
What is risk-averse/risk-seeking behaviour?
Where people make choices based on their emotional reactions to risk rather than a rational assessment e.g. skydiving, being scared of aeroplanes
Why may we question the assumption of rationality?
We have a limited availability to calculate
Social networks influence choices
Emotion often overtakes logic
Altruism (thinking about others) can overtake pure self-interest
We often have a desire for instant rewards
People often stick to default choices
What is loss aversion?
The idea that people are more sensitive to losses than to equivalent gains.
What is anchoring bias?
People tend to focus on an initial piece of information (the “anchor”) and then base their decisions around the anchor, even if it’s not the most relevant/important piece of information.
What does anchoring bias cause?
It causes people to feel like they’re losing out if they stray away from the initial anchor.
Bargain hunting (people often compare a sale price to the original price of an item and think they’re getting a great deal)
Negotiation
What is framing bias?
The idea that the way information is presented can influence people’s decisions and judgments.
What are examples of framing biases?
The “dread risk” framing
The “choice” architecture framing
The decay effect
The “scarcity” effect
What is “dread risk” framing?
Presenting a risk in terms of “how many people will die” rather than “how many people will be saved” can lead to different decisions.
What is “choice” architecture framing?
Arranging options in a specific order or highlighting certain options can influence what people choose.
What is the decay effect?
Offering a less attractive option alongside two more desirable options can make one of the desirable options seem more attractive e.g. cinema popcorn.
What is the “scarcity” effect?
Highlighting limited availability can create a sense of urgency and drive people to act quickly.
What is habitual behaviour?
People develop habits around purchasing and consuming certain products and services which can influence demand.
Habits can be powerful forces in the economy because they can be difficult to break and can influence behaviour in a predictable and consistent way.
What are examples of cognitive biases?
Confirmation bias: the tendency to seek out and remember information that confirms our existing beliefs and ignore information that contradicts them.
Anchoring bias: the tendency to rely too heavily on the first piece of information we receive when deciding.
Availability bias: the tendency to give more weight to information that is easily accessible in our memory.
Overconfidence bias: the tendency to be overconfident in our own abilities and knowledge.
Sunk cost fallacy: the tendency to continue investing in something because of the resources we’ve already invested.
What is bounded rationality?
Acknowledges that people’s decision-making is limited by cognitive biases and other constraints.