Rational economic behaviour Flashcards
Aspects of behavioural economic theory -> Individual economic decision making -> Microeconomics
What is the assumption behind the traditional view of rational economic behaviour?
Individuals are perfectly rational, fully informed, use perfect logic, and aim to achieve maximum economic gain.
Why is the traditional view of rational economic behaviour critiqued?
It is rarely applicable in real-world decision-making due to constraints on information, processing ability, and time.
What is bounded rationality?
Rationality is limited by imperfect information, limited mental processing ability, and time constraints, leading individuals to satisfice rather than maximize utility.
What are the three main limitations of bounded rationality?
- Imperfect information: Individuals cannot know all alternatives and their consequences.
- Limited mental processing ability: Cognitive capacity to analyze complex situations is finite.
- Time constraints: Decisions often need to be made quickly.
How does bounded rationality apply to microeconomics?
- Explains suboptimal consumer and producer decisions.
- Relevant in markets with information asymmetry.
- Justifies policies aimed at simplifying choice, such as nudges or default options.
What is bounded self-control?
The tendency of individuals to fail to act in their long-term interest due to limited self-control.
Provide an example of bounded self-control.
Breaking New Year’s resolutions.
How does bounded self-control relate to economics?
- Explains overconsumption of harmful goods (e.g., smoking, unhealthy food).
- Highlights the role of behavioural interventions like commitment devices (e.g., savings plans).
What is dual-system thinking as proposed by Daniel Kahneman?
A theory distinguishing between System 1 (fast thinking) and System 2 (slow thinking).
What are the characteristics of System 1 (fast thinking)?
- Intuitive, instinctive, and automatic.
- Quick decision-making with minimal effort.
Provide examples of System 1 thinking.
- Buying coffee or groceries.
- Reacting instinctively in a familiar situation
What are the advantages of System 1 thinking?
- Efficient for routine or low-stakes decisions.
- Reduces cognitive load.
What are the limitations of System 1 thinking?
It is prone to biases and errors.
What are the characteristics of System 2 (slow thinking)?
- Reflective, deliberate, and logical.
- Requires concentration and mental effort.
Provide examples of System 2 thinking
- Deciding on a car or house purchase.
- Evaluating investment options.
What are the advantages of System 2 thinking?
- Allows for complex problem-solving.
- Reduces likelihood of impulsive mistakes.
What are the limitations of System 2 thinking?
- Time-consuming and cognitively tiring.
- Overthinking can hinder decisions in high-pressure scenarios.
How do bounded rationality and bounded self-control impact policy design?
- Encourage “nudge” policies, like automatic enrolment in pension plans.
- Simplify information for better consumer understanding (e.g., clear food labelling).
How does understanding irrational behaviours benefit market analysis?
It helps predict real-world outcomes such as market bubbles and poor financial planning.
How do businesses exploit System 1 thinking?
Through branding and advertising.
What are heuristics?
Mental shortcuts used to make decisions under uncertainty (e.g., availability heuristic, anchoring).
What is prospect theory?
A theory by Kahneman and Tversky describing how people evaluate potential losses and gains asymmetrically.
What is loss aversion?
The tendency to prefer avoiding losses over acquiring equivalent gains.
What are framing effects?
Decisions influenced by the way choices are presented.
What is nudge theory?
Small changes in choice architecture that lead to better decision-making without restricting freedom (e.g., default options).
What is Simon’s satisficing model?
A model where decision-makers settle for a satisfactory option rather than the optimal one.
What is Thaler’s mental accounting?
The tendency to categorize money into different accounts, affecting spending and saving behaviour.
What is hyperbolic discounting?
Preference for smaller, immediate rewards over larger, delayed rewards, explaining procrastination and impulsivity.
How does behavioural economics challenge the traditional model of perfect rationality?
By incorporating psychological insights, it provides a more realistic framework for understanding human decision-making.
What are the key applications of behavioural economics?
- Policy design.
- Business strategies.
- Market analysis
